Tuesday, March 15, 2011

House Oversight Chair Says SEC and CFTC Not Coordinating Dodd-Frank Derivatives Regulations

The SEC and CFTC are not properly coordinating the adoption of regulations to implement the Title VII derivatives provisions of the Dodd-Frank Act, said House Capital Markets Subcommittee Chair Scott Garrett (R-NJ). In a letter to CFTC Chair Gary Gensler, Rep. Garrett said that Title VII rules are being proposed by the SEC and CFTC at a rapid pace and without apparent coordination. Further, there seems to be no order in which the rules are being proposed, he added, which can have a profound impact on the financial markets.

For example, the business conduct rules for swap dealers and major swap participants were proposed well before the rules defining swap dealer and major swap participant were proposed. This rulemaking pattern, coupled with an unsustainable pace, is depriving the public of the chance to provide meaningful comment. Chairman Garrett asks how the CFTC will ensure that the public has a meaningful opportunity to comment on all of the derivatives rules and whether the Commission will repropose rules when the overwhelming majority of the comments disagree with the CFTC’s proposals.

Chairman Garrett also wants to know why the CFTC proposes to require market participants using a swap execution facility to send a request for quote to five entities, which is substantially different from the SEC’s proposal. He wants to know if the SEC and CFTC are working together on this proposal.

Given that Congress modeled the market maker concept of the swap dealer and security-based swap dealer definitions on the Securities Exchange Act, Chairman Garrett expects that a reasonable interpretation of those terms would be based on precedent from the federal securities laws. But the CFTC and SEC have taken different approaches to that precedent. The CFTC has rejected the dealer-trader distinction that exists under relevant statutory precedent, and which the SEC acknowledges in interpreting nearly identical language in the definition of security-based swap dealer. The CFTC was asked to explain how it is consistent with legislative intent to have only one agency recognize the dealer-trader distinction embodied in the swap dealer and security-based swap dealer definitions.

The House Chair is also concerned that in some instances the CFTC has gone beyond what Dodd-Frank mandates. For example, while Congress preserved the ability of state pension funds to hedge risk in Dodd-Frank, the CFTC, through its business conduct rules applied obligations on firms essentially making it impossible for pension funds to affordably hedge their exposure. Chairman Garrett asked the CFTC to cite authority allowing it to go beyond the scope of Dodd-Frank in this area.

Chairman Garrett pointed out that the CFTC rulemaking ignores the fact that Congress rejected the Lynch Amendment on ownership limits in the run up to the passage of Dodd-Frank. The CFTC proposes to limit the voting and ownership of some entities in derivatives clearing organizations to 20 percent individual limit and 40 percent aggregate limit, which is almost identical to what the Lynch Amendment would have provided.

The Chair asks the CFTC to explain why it proposed rules based on a Dodd-Frank amendment that Congress ultimately rejected and why it proposed a rule limiting the voting and ownership of derivatives clearing organizations, designated contract markets, and swap execution facilities when it has not conducted a review of these entities as required by Sec. 726(b) of Dodd-Frank. Chairman Garrett would especially like to know how the CFTC determined that a 20 percent individual determination on voting and ownership is necessary for swap execution facilities when such facilities do not yet exist.

The CFTC is also asked how it plans to come up with capital requirements for swap dealers and major swap participants given that the Commission does not have the long-time institutional and technical expertise associated with developing such policies. Chairman Garrett asks if the CFTC will impose Basel capital requirements on non-bank swap dealers.