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CFTC Proposal Exempts End-Users from Margin Requirements

"Don't allocate all [of] your staff to looking at oil and gas reserves. The real bogey in this is going to be systemically risky entities, and that's not quite frankly the oil and gas companies at this point," CFTC Commissioner Scott O'Malia said Tuesday.

End-users, such as oil and natural gas producers, utilities and industrial energy consumers, got their wish Tuesday when the Commodity Futures Trading Commission (CFTC) approved proposed rules that would exempt commercial end-users from margin requirements on derivative transactions involved in the hedging or mitigation of risk.

The proposed rules, which cleared the CFTC by 4 to 1, impose margin requirements for uncleared swaps that are entered into by swap dealers (SD) or major swap participants (MSP), but commercial end-users would be excluded. CFTC Commissioner Scott O'Malia was the sole dissenting vote. This was the 13th open meeting held by the agency to consider proposed rules implementing the regulatory reforms called for in the sweeping Dodd-Frank Wall Street Reform Act.

The proposed rules would apply to SDs and MSPs that are not subject to oversight by prudential (banking) regulators -- the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., the Farm Credit Administration or the Federal Housing Finance Agency. In addition, the proposal would only apply to uncleared swaps that are entered into after the effective date of the final CFTC regulation.

The prudential regulators were to vote Tuesday on similar proposed rules, but theirs would require that end-users pay initial margin and variation margin to banks, according to O'Malia. He believes that end-users will be dissatisfied with the lack of harmonization among the different regulatory agencies. He voted against the proposed rules for this reason.

"Without margin requirements, positions of such magnitude [like those held by American International Group Inc. (AIG) in 2008] will again threaten to destabilize the entire financial system," said Commissioner Michael Dunn. AIG, which was at the center of the financial crisis in 2008, was bailed out by the federal government because it posed a systemic risk to the U.S. financial system.

Under the proposed rules, SDs and MSPs could only accept specified assets, such as cash or Treasuries, as initial or variation margin from other SDs or MSPs or from financial entities. However, in cases where non-financial entities (end-users, for example) posted collateral, they could post nontraditional forms of collateral, such as natural gas in storage or oil and gas reserves. But the value of the assets would have to be reviewed periodically.

"Don't allocate all [of] your staff to looking at oil and gas reserves," O'Malia advised staff. "The real bogey in this is going to be systemically risky entities, and that's not quite frankly the oil and gas companies at this point," he said. .

Commissioner Jill Sommers supported the proposed rules on margin requirements, but she sought more harmonization with rules being considered by domestic regulators and those in the European Union. "Although the [CFTC] proposal is broadly consistent with the proposal being considered by prudential regulators, there are some important differences, particularly with respect to commercial end-users," she said.

Sommers said she believes that regulators "may be overlooking the potential for increased costs that these regulations may be imposing on hedgers and risk management tools." She referred to the proposed rules on margin requirements as "one of the centerpieces of the new regulatory structure" under Dodd-Frank.

A staff member said he believe the proposed rules are "responsive to the concerns" of end-users.

But O'Malia expressed concern that some end-users may be subject to margin requirements because the CFTC's proposed definition of SDs "captures legitimate end-users as swap dealers."

Moreover, he said the proposed margin rules also are a "poster child for [a] failed cost-benefit analysis." But Commissioner Bart Chilton countered that "there's so many unknowns, I think we've done a good [cost-benefit] job with the information that we have."

Chairman Gary Gensler said the Commission also adopted proposed rules establishing swap data record keeping and reporting requirements for counterparties to pre-enactment swaps (those executed prior to the enactment of Dodd-Frank) and transition swaps (those entered into between the enactment date and the future effective date for final rules concerning swap record keeping and reporting). A notice of proposed rulemaking will be published in the Federal Register soon, he said.

In another development, the CFTC and Federal Trade Commission have entered into a memorandum of understanding to facilitate the sharing of non-public information on investigations being conducted by the agencies, including those into the oil and gasoline markets. The agreement will help the FTC enforce its petroleum market manipulation rule, which prohibits fraudulent manipulation of U.S. petroleum markets, according to the two agencies.

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