Friday, May 11, 2012

Business Roundtable Urges Senate to Pass Legislation Clarifying Derivatives End-User and Inter-Affiliate Swaps Exemptions

In a letter to the US Senate, the Business Roundtable urged Senators to pass two pieces of legislation clarifying derivatives provisions of the Dodd-Frank Act. According to the Roundtable, the bills, H.R. 2682, the Business Risk Mitigation and Price Stabilization Act of 2011, and HR 2779, a Bill to Exempt Inter-Affiliate Swaps from the Regulatory Requirements of Title VII of the Dodd-Frank Act, which passed in the House by overwhelming margins, would protect businesses from unnecessary and costly regulation. The BRT urges swift passage of these two bi-partisan bills in the Senate by the end of the current legislative session.

H.R. 2682, which passed the House by a vote of 370-24, creates a narrow, partial end-user exemption from margin requirements for non-financial businesses that use derivatives in their commercial operations.  According to the Business Roundtable, imposing unnecessary margin requirements on these end-users would divert working capital away from productive business use, citing a survey conducted by the Coalition for Derivatives End-Users found that proposed margin rules could reduce capital spending by as much as $5.1 to $6.7 billion among S&P 500 companies alone and cost 100,000 or more jobs.

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.

H.R. 2779, which passed the House by a 357-36 vote,  prevents internal, inter-affiliate trades from being subject to regulatory burdens that were designed to be applied to certain street-facing swaps and ensures that companies are not forced to abandon hedging through central risk-mitigation centers.  These centers achieve stability by allowing U.S. companies to manage commercial risk more effectively and secure better pricing for their derivatives trades. The Roundtable posits that better pricing, in turn, generates savings that companies can pass on to consumers or use to grow their businesses and create jobs.  Without H.R. 2779, said the group, companies would be pushed towards using hedging methods that are riskier and less efficient.

Sponsored by Rep. Steve Stivers (R-OH) and Rep. Marcia Fudge (D-OH), HR 2779 would exempt swaps and security-based swaps entered into by a party that is controlling, controlled by, or under common control with its counterparty. The exempted transactions would be reported to an appropriate swap data repository, or, if there is no such repository that would accept them, to the CFTC in the case of exempted swaps, or the SEC in the case of exempted security-based swaps. Rep. Stivers said that the legislation is designed to ensure that Congress does not penalize companies over the way they choose to do business.

Inter-affiliate swaps are swaps and security-based swaps executed between entities under common corporate ownership. H.R. 2779 exempts inter-affiliate swap and security-based swap trades that are designed to mitigate risks associated with market-facing trades, where a corporation executes a derivatives transaction with an investment bank or other entity, which may be either a swap dealer or security-based swap dealer.

Currently, companies use inter-affiliate swaps to combine positions and centrally hedge risk. This is accomplished by executing most or all of its external swaps or security-based swaps through a single or limited number of affiliates. Despite the significant differences between inter-affiliate swaps and swaps between unrelated parties, the Dodd-Frank Act treats these swaps the same, which increases the cost of hedging risk for end-users. House Report No. 122-344.