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Court Rejects Dodd-Frank Challenge
A U.S. District Court judge in Washington, DC, has dismissed a challenge by Bloomberg LP of the Commodity Futures Trading Commission’s (CFTC) Dodd-Frank regulations of the multi-trillion over-the-counter (OTC) derivatives market. At the same time, a coalition of associations urged the agency to maintain the $8 billion threshold for swap dealing activity that a participant may engage in before it becomes subject to the requirements.
Judge Beryl A. Howell denied Bloomberg’s request for a preliminary injunction of the challenged regulations, saying that Bloomberg “lacks standing to challenge the Commission’s regulation and has not made a showing of imminent and irreparable harm sufficient to warrant the extraordinary relief of a preliminary injunction [Civil Action No. 13-523].”
The Dodd-Frank rules have been the target of a number of lawsuits. Last fall, the U.S. Court of Appeals for the District of Columbia Circuit rejected the agency’s initial rule on speculative trading, saying that the Dodd-Frank “clearly and unambiguously” requires the CFTC to make a finding of necessity prior to imposing position limits. The International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association challenged the rule. It was remanded to the Commission for further consideration (see NGI, Oct. 1, 2012). The agency has appealed the court decision, and is said to be working on a new rule (see NGI, May 6).
At the center of the latest lawsuit is the difference between the liquidation times, and thus margins, for the treatment of swaps on swap execution facilities (SEFs) and demand contract markets (DCMs), such as the New York Mercantile Exchange. The CFTC rule calls for swaps that are executed on an SEFs to have a minimum five-day liquidation time, while permitting equivalent swaps that were are on a DCM to be subject to a minimum one-day liquidation time and lower margins. SEFs were created by the Dodd-Frank law for the specific purpose of trading swaps.
The liquidation time is the estimated amount of time it would take a demand clearing organization (DCO) to liquidate a position held by a clearing member on behalf of its customer in the case of default. All else being equal, a higher liquidation time typically results in a higher initial margin requirement.
Bloomberg “does not allege that it has suffered any injury as a result of the final rule” yet, but it “fears that, because swaps cannot be cleared with lower than a five-day liquidation time, but swap futures can be cleared with as low as a one-day liquidation time, once ‘Phase 2’ clearing begins on June 10, DCOs will set lower liquidation times for swap futures, traded on competitors DCMs, than for swaps traded on Bloomberg’s trading platform,” the court said. Bloomberg is seeking to become an SEF.
The CFTC rules are aimed at moving a significant proportion of OTC trading activity to SEFs to comply with Dodd-Frank, which was signed into federal law in 2010 (see NGI, July 26, 2010). The legislation also requires swaps to be reported to trade repositories and centrally cleared. The $673 trillion OTC derivatives market, which lacked regulatory oversight, “contributed significantly” to the global financial crisis in 2008, the court noted.
Howell said that Bloomberg’s alleged injury “rises or falls with the behaviors of third-party DCOs, who are the entities…who actually decide what liquidation times to set and how much margin to collect. Yet inexplicably Bloomberg has not put forth a single allegation that any DCO has set or intends to set liquidation times for financial swap futures at a level lower than that set for financial swaps. Instead, Bloomberg simply [assumes] the worst-case scenario.”
In another development involving the Dodd-Frank rules, a coalition of five energy associations has urged the CFTC not to lower the $8 billion de minimis threshold of swap dealing activity that a market participant can engage in before it is required to register with the CFTC as a “swap dealer” and become subject to the requirements under new Dodd-Frank.
“We understand that the CFTC may be considering changing the rules issued jointly with the SEC [Securities and Exchange Commission] in the spring of 2012 that established a de minimis threshold of swap dealing activity in which a swap market participant can engage before the entity is required to register with the CFTC as a ‘swap dealer.’
“We are concerned that such action not be taken without a public notice, an opportunity for comment and a full consideration of the impact that such a change would have on the markets for physical commodity swaps and the ability of commercial end-users to hedge or mitigate commercial risks,” wrote the American Gas Association, Independent Petroleum Association of America, Electric Power Supply Association, Edison Electric Institute and the National Rural Electric Cooperative Association.
In April 2012, the CFTC and the SEC set the de minimis level at $8 billion (see NGI, April 23, 2012). It is expected to remain in effect during the phase-in period and then fall to $3 billion after the CFTC conducts a study on the swap markets. The agency said it plans to prepare the study two and a half years after data starts to be reported to swap data repositories. Nine months following the study, the CFTC may end the phase-in period. If not, it will terminate automatically five years after data starts to be reported to the repositories.
The threshold initially started at $100 million when the CFTC approved the proposed rule on swap dealers in December 2010 (see NGI, Dec. 6, 2010). If this threshold had been approved, a greater number of market participants would have been classified as swap dealers and become subject to the Dodd-Frank requirements.
The energy groups urged the CFTC not to unilaterally reduce the threshold below $8 billion, saying it would result in commercial end-users being misclassified as swap dealers, which they said was not the intent of Congress in Dodd-Frank.
“These entities [commercial end-users] did not get us into this crisis and should not be punished for Wall Street excesses…Congress does not intend to regulate end-users as major swap participants or swap dealers just because they use swaps to hedge or manage their commercial risks associated with their business,” wrote former Sen. Chris Dodd (D-CT), one of the architects of Dodd-Frank, and former Sen. Blanche Lincoln (D-AR), a key contributor to the bill, in a letter to their House counterparts after passage of the Dodd-Frank conference report in the Senate. Congress took up the legislation following the 2008 financial crisis on Wall Street.
“Lowering the de minimis limit and potentially misclassifying end-users as swap dealers would do nothing to increase the CFTC’s ability to monitor for manipulation, excessive speculation and system risk in energy markets. What it would do, however, is reduce a commercial end-user’s ability to hedge its commercial risks, and impose unnecessary costs that will ultimately be borne by electric and gas consumers in the form of higher prices,” the five energy associations told the CFTC.
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