Wednesday, July 13, 2011

Regulators Urged to Treat Banks with Limited Swaps Activities as End Users under Dodd-Frank and Exempt Them from Margin Rules

Banking and securities groups urged federal regulators not to impose margin requirements on end users that use swaps to hedge or mitigate commercial risk and to treat banks with limited swaps activities as end users and exempt them from the margin requirements or, if that is not possible, only impose mark-to-market margin on any collateral that may have been negotiated. The groups also asked that third-party margin requirements not be imposed on affiliate transactions. The Dodd-Frank Act does not mandate that the margin rules apply to affiliate swaps transactions, noted the groups, nor is there an overriding policy argument that would support applying the margin rules to affiliate transactions. Affiliate swap transaction counterparties have better information about each other than do counterparties in third-party transactions, noted the groups.

The groups believe that banks with limited swaps activities are end users and that any collateral requirements should be negotiated between the swap counterparties. As noted in a previous comment letter to the CFTC and the SEC on the end-user exception to mandatory swaps clearing requirements, the groups said that the vast majority of banks that use swaps do so in order to manage the risks of their ordinary banking activities and to meet regulatory expectations for asset-liability management. For example, many banks use swaps to hedge interest rate risk on their balance sheet or loan exposure just as other end users do to hedge or mitigate commercial risk.

According to the groups, the same arguments in support of an exemption from the margin requirements for non-financial end users apply equally to financial entities that engage in limited swaps activities and use swaps to hedge or mitigate commercial risk. They posit that Congress did not intend to impose those margin requirements on end users and Congressional statements on this subject are not limited to only non-financial entities.

The Dodd-Frank Act also requires the CFTC and the SEC to consider whether to treat small banks and savings associations the same as other end users and exempt them from mandatory clearing requirements. The groups view this statutory language as indicating that Congress recognized small banks and savings associations use swaps in the same way that other end users do.

The groups further noted that banks with limited swaps activities generally transact in smaller notional amounts and need to customize swaps to loans that they originate. Such swaps would not likely be available on a clearing platform now or in the future, reasoned the groups, because the volume will not be high enough for the clearinghouses to incur the costs that would be necessary to clear them. The time and expense involved in establishing a clearing relationship with a dealer for this low volume would also be prohibitive. If these banks could no longer afford to engage in swaps transactions, concluded the groups, then it would not only increase costs and risks for customers but also decrease the institution’s ability to manage its own financial risk.

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