Friday, October 07, 2011

Senate Legislation Would Codify End-User Exemption and Establish Office of Derivatives within the SEC

Senate Republicans have introduced legislation providing business end-users with a clear exemption from margin requirements and modifying the definition of major swap participant to prevent businesses using derivatives to hedge business risks from being regulated like swap dealers. Many businesses use over-the-counter derivatives to minimize the impact of commodity price, interest rate, and exchange rate volatility in order to maintain stability in earnings and predictability in operations. The Dodd-Frank Improvement Act, S 1650, would also exempt transactions among different parts of a company from clearing and trading requirements so that businesses can efficiently manage their risks. In addition, the legislation would create an Office of Derivatives in the SEC to administer regulations, coordinate oversight and monitor the developments in the market.

The legislation would also extend the July 16, 2011 deadline for the regulatory implementation of Title VII of the Dodd-Frank Act to July 16, 2012. The legislation filed by Senator Mike Crapo (R-ID, and co-sponsored by Senators Mike Johanns (R-NE), Richard Shelby (R-AL), the Ranking Member of the Senate Banking Committee, David Vitter (R-LA), Patrick Toomey (R-PA), Jerry Moran (R-KN) and Mark Kirk (R-IL).
In an effort to remove regulatory uncertainty, the legislatrion requires the SEC and CFTC to jointly publish a schedule outlining the order in which the agencies will consider and implement the final rules. Affected market participants will be able to weigh in and be heard about how the regulations should be adopted and implemented. Agencies will have to work together to come up with a coordinated schedule for proceeding with rulemaking and implementation.

In addition, in adopting the derivatives regulations, the SEC and CFTC would have to take into consideration economic impact, international competitiveness, the interactions of the regulations with one another and the implications of inconsistencies in the approaches taken by the different regulators. The legislation would also give the SEC and CFTC exemptive authority to facilitate orderly implementation of the derivatives rules consistent with the public interest.
Importantly, the legislation would require the SEC and CFTC to give greater consideration to international developments in the derivatives markets. The legislation expands and extends a joint SEC-CFTC study on international swap regulation. It also sets clear bounds on the overseas application of the derivatives requirements, while allowing regulators to stop systemically dangerous transactions intended to evade U.S. requirements.

The new SEC Office of Derivatives would administer the rules of the Commission with respect to security-based swaps and, as necessary, make recommendations to the Commission for new rules or changes to existing rules with respect to security-based swaps. The Office would also coordinate oversight of the swaps market, participants in that market, and infrastructure providers for that market with other relevant domestic and international regulators, as well as monitor developments in the market for swaps and security-based swaps.

The head of the Office will report to the Director of the Division of Trading and Markets and the Director of Risk, Strategy, and Financial Innovation. The Division of Enforcement must consult with the Office before presenting a recommendation with respect to security-based swaps to the Commission. In addition, a representative of the Office must be afforded the opportunity to participate in any inspection or examination of a security-based swap dealer, major security-based swap participant, security-based swap data repository, or clearing agency that clears security-based swaps.

The Director of the Office of Derivatives must submit to the SEC Chair and publish on the public website of the Commission a report describing the activities of the Office during the preceding year, and the developments in the swaps and security-based swaps markets.

The legislation is gaining support from those concerned about the importance to end-users--companies using derivatives to reduce business and financial risk. Thomas C. Deas, Jr., Chairman of the National Association of Corporate Treasurers said the organization supports legislation enabling end-users to continue their cost-effective use of derivatives to manage the commercial risks they face when they make investments to expand plant and equipment, conduct research and development, and to sustain and grow jobs.

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