Thursday, February 16, 2012

House Panel Approves Bi-Partisan Legislation Repealing Bank Swap Push Out Provisions of Dodd-Frank

The House Financial Services Committee unanimously approved legislation repealing swap push out provisions of Section 716 of the Dodd-Frank Act requiring depository institutions to conduct derivatives trades through an affiliate. HR 1838, sponsored by Rep. Nan Hayworth (R-NY), would repeal provisions requiring banks to separate and segregate portions of their derivative businesses.

The legislation repeals provisions in the Dodd-Frank Act that increase systemic risk to the financial system by forcing derivatives trading units from regulated financial institutions into new entities that may be outside the purview of financial regulators. When Congress was crafting the Dodd-Frank Act, financial regulators raised concerns about the risk involved with this provision. For example, then-FDIC Chairman Sheila Bair said that if all derivatives market making activities were moved outside of bank holding companies, most of the activity would no doubt continue, but in less-regulated and more highly leveraged venues.

HR 1838 ensures derivatives trading units can be overseen by financial regulators and increases the capital available to finance job creation and economic activity.

Rep. Hayworth said that the legislation is needed because, under current Section 716, regulatory arbitrage is quite possible putting the US at competitive disadvantage. Rep. Hayworth noted that Section 716 requires banks to conduct swap transactions through subsidiaries or affiliated entities. Pushing out these activities makes them less safe.

An amendment offered by Rep. Jim Himes (D-CT), supported by Rep. Hayworth, that would carve out risky instruments, such as structured swaps and asset-backed securities, was approved by voice vote. These are swaps that are the most risky and should be pushed out of banks.

An amendment proposed by Rep. Hayworth preserving Section 716(i) was approved during subcommittee markup by a voice vote. According to Rep. Hayworth the amendment retains prohibitions on bailouts and prevents the use of taxpayer funds for swap activities. Section 716(i) provides that no taxpayer funds can be used to prevent the receivership of any swap entity resulting from swap or security-based swap activity of the swap entity.

Committee Chairman Spencer Bachus (R-ALA) supports the legislation, noting that repealing these provisions because they could increase systemic risk by forcing derivatives trading away from regulated financial institutions to entities outside the purview of US regulators. Committee Ranking Member Barney Frank supports the legislation, noting that Section 716 comes in on top of the Volcker Rule provisions.

In earlier testimony, ISDA found it difficult to see how Section 716 reduces systemic risk. This is particularly true given that firms face regulatory reporting requirements for all transactions, including transactions exempt from and covered by Section 716.

Such regulatory reporting will help to ensure that exposures can not build up unnoticed in the financial system. Separately, forcing the derivatives business outside of the better-capitalized, better-regulated bank into new stand alone subsidiaries could actually increase risk to the system, said ISDA. Section 716 will also increase risk as it leads to greater inefficiencies and the loss of exposure netting as it requires firms to conduct swaps across multiple legal entities.