The Commodity Futures Trading Commission (CFTC) Thursday narrowly voted out the long-awaited proposal exempting end-users that use swaps to hedge or mitigate commercial risks from the mandatory clearing requirement under the Dodd-Frank Wall Street Reform Act.
By 3-2, the proposal cleared the Commission, with Commissioners Jill Sommers and Scott O'Malia dissenting. Both believe the exemption, as currently proposed, is too narrowly constructed.
The stumbling block is the $10 billion asset limit on exceptions for small financial institutions, credit unions, including farm credit unions, pension funds and municipalities, which remains to be addressed in the proposed rule.
The Dodd-Frank Act, which exempts end-users from mandated clearing, also requires the CFTC to consider whether to exempt small banks, savings associations, farm credit institutions and credit unions from the definition of financial entity and its clearing regulation.
"I welcome public comment on whether any of these groups should be [eligible for the end-user exemption] and, if so, why...I would like to know if the $10 billion cap on total assets meets the congressional intent," Commissioner Michael Dunn said.
"Last week I expressed concerns about a number of the Commission's [proposals] that I felt were too broad or over-reaching. This week my concerns go the other way," particularly with the end-user exemption, Sommers said. "Although we ask questions with regard to that subject, we actually don't propose a framework for how we would go about exempting these small institutions. So in that area, I believe we have read the statute too narrowly," she said.
She questioned how the CFTC would be able to issue a final rule without that framework. Staff agreed, explaining "we won't be able to do a final rule at this point, but there are other options. The Commission may very well issue an order without taking further comments in the Federal Register; that's a possibility." Summers said she feared "delaying going final with the process may have a lot of unintended consequences and may actually go against congressional intent."
"I commend the end-user exemption team for drafting what overall is a very thoughtful and well written proposal. However, I am flummoxed as to why we are failing to fully address the issue of excluding small banks, farm credit institutions and credit unions from the definition of financial entity," O'Malia said.
"All we are going to do today, after almost five months with this language, is punt it. While I can appreciate the staff's decision to pose a series of questions aimed at further informing their consideration of the appropriate criteria for such an exception, we are too far into these rulemakings to begin from square one," he noted.
Drawing the line on exemptions, in some cases, has been difficult, the commissioners agreed. In other cases "a lot of people that have come in and met with us have wanted the line for regulation to begin right after them," Commissioner Bart Chilton said. "In some cases it's laughable who's requested this. We've had hedge funds in here who've said they are end-users, and I've even had somebody suggest that ETFs [exchange traded funds], as the natural counterparty to end-users," should be exempt. "Some of these requests just don't pass the smirk test."
The CFTC also approved proposed rules aimed at establishing external business conduct standards for swap dealers and major swap participants dealing with counterparties. The proposed rules are of "particular interest to me because I believe strong standards...are necessary to prevent another financial crisis," Dunn said.
By implementing strong business standards, "the Commission can establish a meaningful protection for counterparties," he said.
In addition, the Commission cleared a proposed rule on governance requirements for derivatives clearing organizations, designated contract markets and swap execution facilities, and requirements involving the mitigation of conflict of interest. "An inherent conflict of interest [would exit] when a swap deal acts as both an adviser and counterparty to its customers," Dunn said.
The Commission will take up actions on position limits and swap execution facilities (SEF) at a meeting next week. The SEF action had been pulled from Thursday's agenda to take into account opposing views among the commissioners. Summers claimed the measure as it had been presented to the commissioners earlier in the week "was too broad and overreaching" and "defined the SEFs too narrowly."
SEFS were created by the Dodd-Frank Act for the sole purpose of trading swaps.
O'Malia also objected, saying it "requires swaps to trade like futures, when the markets are sufficiently different." Also limiting central order books would "inappropriately burden commerce."
Gensler explained that on position limits, the staff was working on potentially two separate rulemakings, the one governing the spot month and another on all months and aggregated positions. Because the Commission already has rules in place for spot months covering a large number of commodities, they can "move more expeditiously on the spot month" rule, finalizing it "within the next few months." The Commission still must gather data on the all months position limits and that may take longer. Both, however, will be aired next week (Dec. 16).
Chilton decried the delay, saying there was new speculative data showing "more positions coming into markets than ever before. There is some disagreement about the impact of speculators on prices, but any impact is unacceptable. We have just seen gas prices raised 10 cents; crude's around $90; it has gone up $7 in two weeks." There have been large concentrations of trading "with more than 20% by a single trader in natgas." Chilton said he supported "moving expeditiously" on the spot month.
Long-time futures market operator, CME Group, has said it has no problem with a new position limits proposal. "We've had position limits on all of our products," said Joe Raia, CME Group managing director of energy and metals, talking Thursday with reporters in Houston.
"Our customers are comfortable with it. They know that we have limits...It's nothing new for them at all; they've been dealing with it for years."
The CFTC now has taken action on 36 proposals to implement the financial reform act and still has a long way to go, "There are certainly a lot of things that aren't known yet, a lot of rulemakings that haven't come out," Raia said. "We're looking to make sure that we're heading in the right direction given all the changes that could be coming. Certainly there is more unknown than there is known right now."
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