Thursday, March 29, 2012

House Passes Legislation Codifying Derivatives End User Exemption

The House passed by a 370-24 vote the Business Risk Mitigation and Price Stabilization Act, HR 2682, providing clarity to the derivatives title of the Dodd-Frank Act by reconfirming the end-user exemption from margin and capital requirements. End-users are firms and companies that use derivatives to manage their risks, not to speculate. During the debate on Dodd-Frank, Congress made its intent clear that the derivatives title was not meant to impose margin requirement on end users. Yet, regulators have interpreted the derivatives title to give them authority to impose margin requirements on end-users. The legislation was sponsored by Representatives Michael Grimm (R-NY), Gary Peters (D-MI), Austin Scott (R-GA), and Bill Owens (D-NY).

The end users exemption in HR 2682 allows end-users to continue to use derivatives to maintain low and stable prices for consumers and will free up capital. The legislation is based on the consensus view that the use of derivatives by commercial end-users did not pose a risk to the larger economy, said Rep. Peters. The narrowly crafted legislation clarifies that Congress intended that commercial end-users who are not engaged in harmful speculation should not be required to divert capital away from job creation. The legislation will ensure that community banks, agriculture co-ops and energy utilities can continue to hedge risk, said Rep. Owens.

As envisioned by the legislation, true end-users are companies that use derivatives to manage an actual business risk, generally to hedge against fluctuating prices, currency rates, or interest rates, and not to speculate. HR 2682 clarifies that end-users employing derivatives to hedge legitimate business risk are exempt from posting margin, consistent with the Congressional intent of Dodd-Frank. Forcing true end-users to post margin can have several negative consequences, said the sponsors, including pushing the costs of hedging so high that firms stop hedging, resulting in a detrimental rise in prices for consumers. In addition, capital would be restricted and the high costs of hedging could drive business overseas to foreign derivatives markets. H.R. 2682 eliminates the margin requirement and thus helps prevent these negative consequences from occurring.

The Dodd-Frank Act does not require regulators to impose margin requirements on end users and the legislative history clarifies that Congress did not intend to impose margin requirements on non-financial end users. Nonetheless, the legislation was driven by end user uncertainty about whether they will be subject to margin requirements.

At the markup of the bill in the House Ag Committee, Chairman FRank Lucas (R-OK)said that, while the CFTC has followed congressional intent, the banking regulators have proposed to require margin in the form of cash or highly liquid securities from non-financial end users, thereby ignoring congressional intent. Thus, he viewed this legislation as critical to reaffirming congressional intent to expressly and clearly provide an end-user exemption. In this regard, Chairman Lucas noted a letter sent by Senators Chris Dodd (D-CT) and Blanche Lincoln (D-AK) to House oversight chairs stating that the Dodd-Frank Act does not authorize federal regulators to impose margin on end users that use swaps to hedge or mitigate commercial risk.

Rep. Grimm said that HR 2682 clarifies the intent of Congress to provide an explicit exemption on the posting of margin by end users. He emphasized that the legislation ensures that federal regulators will not impose margin requirements on true ends users that use swaps to manage their business risks, like to lock in the cost of raw materials.

Forcing true end-users to post margin can have several negative consequences, he noted, such as the costs of hedging could be become so high that they stop hedging, resulting in a detrimental rise in prices for consumers. Also, capital would be restricted that would otherwise be used for job creation or reinvestment to make US companies more competitive in the global economy. Further, the high costs of hedging could drive business overseas to foreign derivatives markets and could also increase regulatory arbitrage

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