Friday, April 06, 2012

House Legislation Was Designed to Clarify Dodd-Frank Intent on End User Exemption

Sponsors of bipartisan legislation providing a clear exemption from margin requirements imposed by the Dodd-Frank Act on swap transactions for end users who use derivatives to hedge their business risks and whose swap transactions do not pose a systemic risk to the financial system outlined the need for the measure in light of regulatory proposals. The Business Risk Mitigation and Price Stabilization Act, HR 2682, passed the House by a vote of 370-24. The end user 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.

Following a late night of the Dodd-Frank House-Senate conference committee deliberations, numerous assurances were made that margin would not be required on end-users’ transactions. These assurances were subsequently followed up by formal letters and colloquies by the architects of the Dodd-Frank Act. Everyone was told that Congress clearly intended for the language to exempt end-users from the bill’s margin requirements.

Unfortunately, noted Rep. Scott Garrett (R-NJ), the financial regulators have interpreted it a different way, and they have interpreted Dodd-Frank’s somewhat rushed language as not providing a clear exemption for these end-users. The legislation provides businesses with the certainty that they need to use derivatives to hedge against business risk, said Rep. Garrett. End-users were not the cause of the financial crisis, he observed, and by any measure whatsoever, end users are not systemically significant. (Cong Rec. (Mar 26, 2012) p. H1551)

Requiring end-users to be subject to a mandatory margin requirement basically forces commercial entities to act like banks, said Rep. Garrett. Without a margin exemption, the cost of hedging business risks would rise dramatically and that would needlessly tie up working capital that otherwise could and should be used to expand
business investments, build factories, or create jobs.

According to Rep. Al Green (D-TX), HR 2682 clarifies Congress’ intent when passing Dodd-Frank by more clearly exempting end-users that are only using swaps to hedge or to mitigate commercial risk. H.R. 2682 is also consistent with a colloquy between Representatives Barney Frank (D-MA) and them House Ag Chair Colin Peterson, as well as a letter from Senators Blanche Lincoln (D-AK) and Senator Christopher Dodd (D-CT), which noted that the reform legislation provided the regulators with sufficient authority to exempt end users from margin requirements. (Cong Rec. (Mar 26, 2012) p. H1551)

Rep. Michael Grimm (R-NY), the author of HR 2682, said that the legislation clarifies the congressional intent under the Dodd-Frank Act and provides an explicit exemption from having to post margin for true commercial end users of over-the-counter derivatives. Despite clear legislative history to the contrary, he noted, regulators continue to misinterpret the Dodd-Frank Act as giving them authority to impose margin requirements on end users. The legislation would ensure once and for all that true end-users are not subjected to margin requirements that Congress never intended to be applied, emphasized Rep. Grimm, and also ensures that regulators do not attempt to exercise authorities they were never granted by Congress in ways that will certainly do harm to the economy, specifically, by diverting working capital away from investment and expansion. (Cong Rec. (Mar 26, 2012) p. H1552)

True end users are firms and companies that use derivatives to manage their various financial risks, he noted, such as firms that use these products to lock in the costs of raw materials that they are going to need in the future, which ultimately protects consumers and creates jobs. If true end users were required to post margin, he posited, their hedging costs may become so high that they could abandon the practice, leading to great price variations for raw materials and, ultimately, an increase in consumer prices for a whole host of products from food to energy. (Cong Rec. (Mar 26, 2012) p. H1552)

Rep. Michael Conaway (R-TX), chair of the Commodities and Risk Management Subcommittee, noted that the legislation simply affirms the original position of Congress that nonfinancial end users do not need to tie up scarce resources to participate in the swaps markets. Non-financial end users represent less than 10 percent of the swaps market he observed, and have never posed a systemic risk to the broader financial markets. Chairman Conaway assured that the Business Risk Mitigation and Stabilization Act would not undermine the established goals of Dodd-Frank. (Cong Rec. (Mar 26, 2012) p. H1553)