House Panel Approves Legislation on Derivatives End Users Exemption, Inter-Affiliate Swap Exemption, and Mandating Joint SEC-CFTC Regulations on Cross-Border Transactions

The House Agriculture Committee marked up and approved a series of bills amending the Dodd-Frank Act to codify the derivatives end users exemption, create an exemption for inter-affiliate swap transactions, mandate joint SEC-CFTC regulations on cross-border derivatives transactions, limit the swap desk push out provision to complex and risky derivatives involving structured finance, and allow data-sharing between U.S. and non-U.S. regulators. The Committee also approved legislation mandating that the CFTC conduct a robust cost-benefit analysis of proposed regulations. All of the bills were approved with a bi-partisan majority, all but one by voice vote. Committee Chairman Frank Lucas (R-OK) described the legislation as common sense changes to Dodd-Frank and a step in to correct aspects of Dodd-Frank.

The Inter-Affiliate Swap Clarification Act (H.R. 677), approved by voice vote, would ensure that derivatives transactions between affiliates in a single corporate group are not regulated as swaps under the Dodd-Frank Act. The legislation would prevent internal, inter-affiliate swaps from being subject to costly and duplicative regulation.

There is currently no distinction made in Dodd-Frank between external, or market-facing, swaps and internal swaps between two entities within the same corporate organization. The legislation would exempt inter-affiliate swaps from margin, clearing, and execution requirements under Dodd-Frank. In order to ensure a targeted application, there are also important consumer protections in the bill, including a provision ensuring that companies wishing to use this exemption are truly affiliated. The bill would also establish reporting requirements for inter-affiliate swaps. The legislation also contains important anti-evasive provisions authorizing regulators to ensure that this exemption cannot be used to circumvent other regulations within Dodd-Frank. The legislation maintains the authority of state and federal regulators to ensure the safety and soundness of financial institutions. Similar legislation in the 112th Congress, H.R. 2779, passed the House by a vote of 357-36 in March 2012.

The Swap Jurisdiction Certainty Act (H.R. 1256), approved by voice vote, would direct the SEC and CFTC to adopt joint regulations on the regulation of cross-border derivatives transactions. Chairman Lucas noted that H.R. 1256 would also provide that no guidance from the Commissions in this area would have the force of law. Rep. David Scott (D-GA) said that the legislation addresses issues around the extra-territorial application of the Dodd-Frank Act. Non-US persons would not be subject to the Dodd-Frank Act if, as determined by the Commissions, they are subject to an equivalent  derivatives regulatory regime in a G20 country. Rep. C. Michael Conaway (R-TX), Chair of the Commodities and Risk Management Subcommittee, noted that the bill allows the SEC and CFTC to designate other jurisdictions outside of the G20 as equivalent and thus eligible for the exemption.

The Swaps Regulatory Improvement Act (H.R. 992), approved by a vote of 31-14, would modify Section 716 of the Dodd-Frank Act, the bank swaps push-out provision. The legislation would amend Section 716 to ensure that federally insured financial institutions can continue to conduct risk-mitigation efforts for clients like farmers and manufacturers that use swaps to insure against price fluctuations. The bill modifies section 716  to allow commodity and equity derivatives in banks with federal deposit insurance. However, derivatives involving structured finance transactions would still have to be pushed out.

Senate Banking Committee members Senators Kay Hagen (D-NC) and Patrick Toomey (R-PA), along with Agriculture Committee members Senators Mike Johanns (R-NE) and Mark Warner (D-VA) have introduced companion legislation in the Senate.

Currently, under Section 716, federally insured banks would not be permitted to conduct certain swaps trading, including trading of commodity, equity, and credit derivatives, thus compelling the banks to push-out that activity into separately capitalized non-bank affiliates. By prohibiting this activity in federally-insured institutions, regulators would lose some oversight. This legislation will ensure that these swaps take place within institutions that are more closely monitored by federal regulators.

The Swap Data Repository and Clearinghouse Indemnification Act (H.R. 742), approved by voice vote, would ensure that U.S. and foreign regulators can share necessary swaps data to increase market transparency and facilitate global regulatory cooperation. The Dodd-Frank Act requires swap data repositories and clearing organizations to make data available to foreign regulators. But, under Dodd-Frank, this data-sharing can happen only if foreign regulators agree to indemnify the U.S. entity and U.S. regulators for any corresponding litigation expenses that might arise. Foreign regulators have been unwilling or unable to agree to such indemnification agreements under their own legal structures, so the indemnification provisions prevent the necessary data-sharing. To ensure that U.S. and foreign regulators have access to derivatives data, H.R. 742 would eliminate the indemnification provisions that would otherwise impede the necessary data-sharing arrangements.

Last year, the SEC recommended that Congress consider removing the indemnification requirement added by the Dodd-Frank Act. The indemnification requirement interferes with access to essential information, said Ethiopis Tafara, Director of the SEC Office of International Affairs, including information about the cross-border OTC derivatives markets. In removing the indemnification requirement, Congress would assist the SEC, as well as other U.S. regulators, in securing the access it needs to data held in global trade repositories.

The Business Risk Mitigation and Price Stabilization Act (H.R. 634), approved by voice vote, codifies an exemption for non-financial end users that use derivatives in their commercial businesses from the margin requirements of Dodd-Frank. According to Chairman Lucas, H.R. 634 ensures that end users can continue to use derivatives to hedge business risk. He added that Congress never intended for non-financial end-users to be required to post margin under Dodd-Frank. Committee Ranking Member Colin Peterson (D-MN) said that the legislation was needed because the banking regulators ignored the will of Congress and required end-users to post margin. Rep. Michael McIntyre (D-NC) said that  true end users use derivative to protect from losses and ensure stability and not to engage in speculation, adding that  H.R. 634 will not apply to the major financial institutions. This is a critical bill, he emphasized, to ensure that the intent of Congress not ignored.

The Public Power Risk Management Act (H.R. 1038), approved by voice vote, would allow non-financial entities to enter into swap transactions with government-owned utilities without being designated a swap dealer under the Dodd-Frank Act.

Cost-Benefit Analysis

Finally, the Committee approved, by voice vote, legislation H.R, 1003, requiring the CFTC to quantify the costs and benefits of future regulations and orders. The bill would also mandate that the CFTC quantify the impact of market liquidity, a marked change from the current policy of just considering costs. Chairman Conway noted that H.R. 1003 is prospective legislation and thus would not require the CFTC to go back and do a cost-benefit analysis on regulations that the Commission has already adopted.

In addition to market liquidity, H.R. 2003 lists a number of other factors that the CFTC must consider in doing the cost-benefit analysis, including price discovery, efficiency, competitiveness and available alternatives to regulation. The CFTC must also consider if the regulation is inconsistent or duplicative of other federal regulations. The legislation would also update the CFTC’s current requirements to require the examination of the impacts on the previously unregulated swaps markets, a necessary addition because of new authority given to the CFTC under Dodd-Frank. It also would require the CFTC’s chief economist be involved in the cost-benefit analysis, a recommendation made by the commission’s inspector general. Only future proposed rules would be affected; the legislation would not require retroactive analysis of pending proposals.