Taking Stock of Legislative Proposals to Amend Dodd-Frank's Derivatives Rules
Fanni Koszeg | Bloomberg Law
The Congressional Research Service (CRS) published a report (Report) on derivatives-related legislation in the current Congress. A majority of these proposals would amend or expand upon certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). In particular, many of the proposals would ensure a wider range of exemptions from new regulations for so called end-users of derivatives products. Some would repeal Dodd-Frank in its entirety; others would repeal certain core provisions of the law. Finally, a fair number of proposals have been submitted in response to voter outrage due to unexplained price fluctuations in commodity prices such as gasoline, blamed by some on excessive speculation in derivatives markets.
Background—Dodd-Frank and Derivatives Markets
The Report recounted which elements of derivatives law reform generated controversy prior to and in the aftermath of Dodd-Frank’s enactment. One of Dodd-Frank’s primary goals was to decrease systemic risk in swaps markets through clearing derivatives, but new clearing requirements impose additional costs on those who trade derivatives. One major area of controversy remains the impact of these new provisions on non-financial firms that use derivatives solely to hedge their risks in the underlying markets in which they operate. Many of these firms complained during the debates over Dodd-Frank that since their use of derivatives does not contribute to systemic risk, they should not be subjected to the cost of clearing derivatives, including onerous margin requirements.
Another important area of concern—particularly for swap dealers and major swap participants—is proposed trading requirements. Accordingly, a bi-partisan proposal to re-define Swap Execution Facilities (SEFs) to address those concerns has been moving forward in Congress. In addition, the role of speculation in oil and other commodity markets has attracted a lot of congressional attention due to sharp rises in commodity prices in 2008 and early 2011. A number of congressional committees held hearings on the topic and several bills address the impact of financial speculation and derivatives on spot commodity prices.
Proposals to Amend Dodd-Frank
— End-User Concerns
Section 723 of Dodd-Frank includes a broad exemption from the clearing requirement for market participants that are primarily nonfinancial in nature. Nonetheless, these derivatives end-users have continued to be concerned that Dodd-Frank, or the rulemaking process by the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC), could impose indirect costs on them. The Report described that H.R. 1610 would create a specific exemption from margin and capital requirements on swaps where at least one of the counterparties is not (1) a swap dealer or major swap participant; (2) an investment fund that is an issuer of equity securities to more than five unaffiliated persons, an entity not primarily invested in physical assets, or a hedge fund; (3) a commodity pool; or (4) Fannie Mae or Freddie Mac. H.R. 2682 contains an exemption from margin requirements on the uncleared swap positions of swap dealers and major swap participants for swaps with nonfinancial end users.
H.R. 2586 is a bi-partisan proposal in a fairly advanced stage, which would significantly amend the definition of SEFs. The bill addresses several aspects of proposed CFTC and SEC requirements that many industry participants find onerous, including a requirement that offers be made available to a minimum number of traders or that bids or offers be displayed or delayed for a particular period of time on SEFs. For more background on the debate on trading related regulatory proposals and this bill, see How Much Transparency Will Dodd-Frank Bring to Swaps Markets?, Bloomberg Law Reports®—Derivatives Law, Vol. 3, No. 1 (Jan. 9, 2012).
— Duties of Swap Dealers
H.R. 3045 would amend the Dodd-Frank provision that defines certain counterparties as “special entities” to which swap dealers owe a higher standard of care by removing ERISA plans from the definition of special entity altogether, and by specifying that the duty of swap dealers to “act in the best interests of a special entity” shall not be construed as a fiduciary duty.
— Inter-Affiliate Transactions
H.R. 2779 would exempt from the definition of “swap” any contract between a counterparty and its affiliate. These swaps would be exempted from all regulatory requirements with the exception of reporting requirements. The bill received strong support from industry participants, end users in particular, and was marked up and referred to the full Committee on Financial Services and is under further consideration in the House Committee on Agriculture.
— International Application
H.R. 3283 proposes to limit the extraterritorial reach of Dodd-Frank by exempting swaps and security-based swaps between U.S. and non-U.S. persons from regulatory requirements with the exception of reporting requirements. Foreign registrants as swap or security-based swap dealers would only be subject to Title VII with respect to contracts with non-affiliated U.S. counterparties.
— Repealing Some or All of Dodd-Frank and Imposing Constraints on Regulators
The Report mentions several proposals to repeal Dodd-Frank in its entirety, proposed both in the House and the Senate by Republican members. These would effectively result in a return to the swap regulation regime created by the Commodity Futures Modernization Act (CFMA) of 2000, which exempted swaps from most of the provisions of federal commodities laws. Other proposals would repeal or significantly amend certain specific important provisions. One such bill is the above discussed H.R. 2586 amending trading requirements. In addition, H.R. 1838 would repeal Section 716 of the law, which contains restrictions on federal assistance to “swaps entities.” (This proposal received support from a majority of industry participants at a congressional hearing last year.)
H.R. 1840 would constrain regulators by imposing additional obligations regarding the cost-benefit analysis of new regulations. Under the bill, the CFTC would be permitted to propose or adopt a regulation only based on a reasoned determination that the benefits of the intended rule justify the costs. The bill sets out a number of factors the CFTC must consider, including the impact on the efficiency, competitiveness, and financial integrity of futures and swaps markets, and whether the regulation is tailored to impose the least burden possible on society.
Proposals to Curb Excessive Speculation
The Report described several bills—mostly by Democratic members of the House and the Senate—that intend to reduce excessive speculation in commodities, which is thought to harm consumers by causing price fluctuations that do not seem driven by the fundamental forces of supply and demand. Some of these proposals, such as H.R. 2328, would require the CFTC to impose position limits (both in swaps and futures markets) on speculative positions in certain commodities (e.g., crude oil, gasoline, and diesel) that may have an impact on gas prices. The bill would expire when the CFTC establishes position limits pursuant to Title VII of Dodd-Frank, which the CFTC has done, albeit with much resulting controversy.
Other bills, such as H.R. 2003 seek to reduce speculation by imposing taxes on speculators’ trades. This proposal would impose a tax of 0.01 percent of the value of each oil future, option, and swap contract traded. Commercial traders who use derivatives to hedge their risks in physical commodity markets and financial institutions trading on their behalf would be exempt from the tax. Monies collected would fund federal regulation of these markets, that is, the CFTC.
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