Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, Wednesday offered a manager’s amendment to his over-the-counter (OTC) derivatives bill that would exempt end-users — such as energy producers and consumers — from having to trade on exchanges if they use derivatives to hedge commercial risk. A roll call vote on the proposal, which appears to have the support of the committee, is expected Thursday.
While initially he believed all derivative transactions should be traded on exchanges, Frank said he changed his mind following “conversations with end-users…who are hedging not because they think it’s a good way to make money, but because they are making product or [providing] a service and want protection against volatility.”
Those who are “end-users, the producers, will have an exemption as long as they are not major swap participants,” he said during the first day of mark-up on the OTC derivatives bill (HR 3795). The measure defines a “major swap participant” as anyone who maintains a substantial net position in outstanding swaps other than for hedging commercial risk.
Frank said he hopes to wrap up mark-up by the end of the week (see Daily GPI, Oct. 8). The House Agriculture Committee will then proceed to mark up its own OTC derivatives measure (see Daily GPI, Oct. 13). Frank said he expects the House to vote on legislation by “no earlier than mid or late November. [It will be] dealt with in the Senate, and not enacted until the end of this year” at the earliest.
An end-user “could lose that exemption if you are judged by the regulators to be engaging in a pattern of activity that puts counterparties at risk,” Frank cautioned. Derivative transactions between financial institutions would be traded on exchanges, he said.
A commercial hedger who decides to do some financial hedging will not be relegated forever to the exchanges, according to Frank. “The fact that you do some financial hedging does not mean you would always have to trade on the exchange.” A company would not be branded with a “Scarlet Letter” requiring it to always transact business on exchanges, he said.
Frank noted that commercial hedgers would not be fully exempt. “If you do not have to trade on an exchange, you will will have to make public the fact of [your] trade and the pricing. There will be no more hidden trades. There will be no more trades in which we don’t know the price.”
“We like the direction that you [Frank] were initially moving last week,” but not this, said Rep. Scott Garrett (R-NJ). This is “180 degrees [in the] absolute other direction.”
Rep. Spencer Bachus of Alabama, the ranking Republican on the committee, supported Frank’s proposal. “You don’t have to put them [OTC derivative transactions] in the exchange to make them transparent,” he said.
“If we can keep these off exchanges and accomplish our [goals of] disclosure and transparency, we’re far better off,” Bachus said.
Some of the committee members were concerned about the direction of the bill, saying it appeared to be targeting small to medium-sized companies that had nothing to with creating the economic meltdown last fall.
The committee approved an amendment, offered by Rep. Christopher Lee (R-NY), that would grandfather existing derivatives contracts. He said the aim of his proposal was to protect existing contracts. Upsetting these contracts could drive customers away from using derivatives, Lee noted.
Over the objection of Frank, the committee accepted an amendment, offered by Rep. Judy Biggert (R-IL), to strike a provision in the manager’s amendment that would allow the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), rather than the exchanges, to set margin requirements.
Biggert argued that there hasn’t been any problems with the exchanges setting margin requirements, and that the CFTC already has authority to set margins in emergency situations. She further noted that the CFTC was not under the jurisdiction of the House Financial Services Committee, but rather the House Agriculture Committee.
Frank said the setting of margins should be an “appropriate public function.” He further noted that “we’re going to be driving a lot more business to the exchanges” as a result of the legislation.
He conceded, however, that Biggert was right on the jurisdictional question. “If the Agriculture [Committee] has a strong position on this, they will prevail” in the end.
“I’m not [sure] a sufficient case has been made for the government to step in and set margin requirements,” said Rep. Jeb Hensarling (R-TX). Congress shouldn’t “err on the side of regulators, who blew it in the first place.”
The committee also passed an amendment, offered by Rep. Bill Foster (D-IL), that calls for a study to be conducted on the “desirability and feasibility” of whether to combine the CFTC and SEC into one agency to regulate the derivatives market (see Daily GPI, April 1, 2008).
Frank initially called the proposal “premature,” but recommended that it be revised to be more neutral. “I believe strongly if we were starting from scratch that we wouldn’t have two agencies so I think it’s [the study] reasonable,” he said.
“We are creating some sort of Mulligan stew” with this proposal, objected Rep. Frank Lucas (R-OK), who also sits on the House Agriculture Committee.
Given the sweeping changes that will be made to the OTC derivatives market as a result of the legislation, Bachus proposed that companies be given more than 180 days from enactment to comply with the bill’s requirements. Frank declined to extend the deadline, but agreed that regulators should be given more flexibility in the rulemaking process.
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