Thursday, July 18, 2013

House Passes Legislation Directing FSOC to Study Differences between E.U. and U.S. Credit Derivatives Valuations

The House passed legislation by a vote of 353 to 24 to require the Financial Stability Oversight Council (FSOC) to conduct a study and report to Congress on the likely effects that differences between the U.S. and other jurisdictions, particularly the European Union, in implementing the derivatives credit valuation adjustment capital requirement would have on United States financial institutions that conduct derivatives transactions and participate in derivatives markets. The study would also be required to examine the impact on end users of derivatives and on the international derivatives markets. According to Rep. Stephen Fincher (R-Tenn), the sponsor of the bill, the Financial Competitive Act, H.R. 1341, is needed because of the potential negative impact of Basel III on the U.S. economy.

FSOC study. Specifically, H.R. 1341 requires that the FSOC study include an assessment of the extent to which there are differences in the approaches that the United States and other jurisdictions are taking regarding implementation of the derivatives credit valuation adjustment capital requirement, and the nature of the differences and the impact that the differences would have on U.S. financial institutions that conduct derivatives transactions and participate in derivatives markets, including their ability to serve end users of derivatives.

The study must examine pricing and other costs of, and services available to, end users of derivatives in the United States and other jurisdictions, as well as the competitiveness of U.S. financial institutions and derivatives markets, including the extent to which differences in the credit valuation adjustment capital requirement could shift derivatives business among jurisdictions. The study must also explore the interaction between differing credit valuation adjustment capital requirements and margin rules.
The FSOC study must recommend steps that Congress and the federal financial regulatory agencies that compose FSOC, including the SEC and CFTC, should take to minimize any expected negative effects on U.S. financial institutions, derivatives markets, and end users. The study must also make recommendations encouraging greater global consistency in the implementation of internationally agreed upon capital, liquidity, and other prudential standards.

Rep. David Scott (D-Ga), a co-sponsor of the legislation, has noted that certainty and uniformity are needed on the calculation of the derivatives credit valuation adjustment as it relates to Basel III capital requirements. Financial Services Committee Ranking Member Maxine Waters (D-Cal), in supporting H.R. 1341, observed that regulators must ensure that the calculation of the derivatives credit valuation adjustment is uniform and does not disadvantage U.S. financial institutions.
The Committee approved an amendment sponsored by Rep. Joyce Beatty (D-Ohio) that clarifies that the study must also indentify any risks and threats to financial stability, thereby recognizing FSOC’s mandate to maintain oversight of financial stability. The FSOC study must consider the cost of failing to take regulatory action as well as the cost of taking regulatory action. According to Ranking Member Waters, the amendment requires the FSOC study to report on the impact not just on derivatives markets but also on the wider markets as well.

E.U. Directive. The European Union is implementing Basel III through the vehicle of the Capital Requirements Directive IV (CRD IV), which would exempt E.U. supervised swap dealers from certain Basel III capital mandates, specifically the credit valuation adjustment, when doing business with non-financial end users, pension funds, and sovereign entities. The securities industry finds the CRD IV exemption troubling in that it is a diversion from a uniform application of capital standards and will result in an unlevel playing field for U.S. and other non-E.U. dealers.
Thus, the securities industry supports H.R. 1341 as part of an effort to promote consistent international standards that provide a level playing field, while avoiding market distortions.
Rep. Fincher noted that Canada recently announced a one-year delay of the derivatives credit valuation adjustment, despite having finalized the rest of Basel III, citing the uncertainty around the provision’s global implementation and its effect on non-financial entities.

A Committee staff memorandum issued in connection with the markup noted that the E.U. exemption for derivatives transactions with sovereign, pension fund, and corporate counterparties has raised concerns that derivatives transactions will be subject to different capital requirements and that the credit valuation adjustment could distort the pricing of trades and limit the amount of liquidity available for non-financial U.S. derivatives end-users, as their transactions would not receive the exemption.


The FSOC study is due within 90 days of enactment to the Chairman and Ranking Members of the Committees on Agriculture and Financial Services of the House of Representatives, as well as the Chairman and Ranking Members of the Senate Committees on Agriculture and Banking.

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