Riding high from their success with health care legislation last week, Democrats made overhaul of the financial regulatory system their next priority. The Senate Banking Committee took the first step last Monday, voting out a bill in less than a half hour to enact sweeping reforms. The measure drew fire from the energy industry for its failure to exempt end-users, who use over-the-counter (OTC) derivatives to hedge commercial risk, from the proposed central clearing and trading requirements for the nearly $500 trillion OTC derivatives market.
Because no amendments were offered and it was a straight up-and-down vote, the measure cleared the Senate banking panel by 13-10 along partisan lines. Committee Republicans decided to save their amendments for the floor debate, which some said was a major strategic misstep because it sent a Democrat-sponsored bill to the floor with little Republican input.
The Senate banking legislation calls for regulation of the heretofore unregulated OTC derivatives market. But unlike the measure passed by the House in December, it does not give end-users, such as producers and industrial customers, a blanket exemption from the requirement that OTC transactions be cleared and traded on regulated exchanges.
Instead it gives the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission the authority to exempt a derivative swap from the clearing-trading requirements if one of the parties to the swap is not a swap dealer or a major swap participant (financial institution), or no derivative clearing organization will accept the swap for clearing. In contrast, the House bill carves out a specific exemption for commodity trades involving end-users or commercial traders hedging commercial risk (see NGI, Dec. 14, 2009).
Senate Banking Chairman Christopher Dodd (D-CT) and Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, have pledged to begin work on harmonizing the two bills.
“While [the American Petroleum Institute] supports efforts by Congress to improve transparency and accountability in U.S. financial markets, we are concerned by the lack of a strong, clear exemption for end-users from a clearing mandate and margin requirements” in the Senate bill, said the API, which represents major oil and natural gas producers.
“Energy commodities account for about one half of 1% of the notional value of all over-the-counter derivatives. Still, these OTC derivatives serve an important function for the oil and natural gas industry and thousands of other businesses in the United States. They are used as a risk-management tool to hedge against fluctuations in commodity prices, interest rates and currency exchange rates, creating market stability and keeping costs down for businesses and the consumers who use their products,” the producer group said.
“With such a low percentage of total derivatives transactions, requiring end-users to exchange trade, centrally clear or margin their hedges will do nothing to address systemic risk. We remain hopeful a bipartisan agreement can be reached that preserves the ability for energy end-users to utilize OTC derivatives to hedge risk.”
Sen. Judd Gregg (R-NH), who supports an end-user exemption, hasn’t given up hope that he and Sen. Jack Reed (D-RI) will be able to develop a bipartisan proposal on regulation of OTC derivatives to replace Dodd’s language. “I am hopeful that we can continue to work toward developing a final bipartisan product in this area before any legislation reaches the Senate floor,” he said. Dodd charged Gregg and Reed with the responsibility of crafting a substitute proposal, but they have been unsuccessful so far.
“We’re disappointed because [Dodd’s] manager’s amendment did not provide an exemption for manufacturers from clearing and margin requirements,” said Paul Cicio, president of the Industrial Energy Consumers of America. “Our priority is [getting an exemption] from clearing,” he noted, but “we’re OK with [the requirement that] transactions be traded over exchanges.”
And as for the margin language in the Dodd bill, Cicio estimated that a single manufacturer would be required to tie up $50-100 million in capital in margin requirements.
He argued that manufacturers account for only 5% of the derivatives traded and “do not pose a risk to the banking system.”
The energy industry’s attention will now turn to the Senate Agriculture Committee, which is expected to unveil its own OTC derivatives bill later this month or in early April. Susan Ginsberg, vice president of crude oil and natural gas regulatory affairs for the Independent Petroleum Association of America, said the producer group has received assurance from Agriculture Committee Chairman Blanche Lincoln (D-AR) and staff that their bill will provide an end-user exemption.
“We need to make sure it [Senate Agriculture] gets it right” when it comes to an exemption for end-users, Cicio said. If the agriculture panel proposes an end-user exemption, the two Senate committees — Banking and Agriculture — would likely then have to get together to reconcile their proposals.
CFTC Chairman Gary Gensler, who opposes any exemptions from regulation of OTC derivatives, applauded the banking committee’s action. The vote by the “represents historic progress toward comprehensive regulatory reform of the over-the-counter derivatives marketplace.” He said he lwas looking forward to working with Dodd, Lincoln and others in the Senate and House on legislation that “promotes transparency and lowers risk in the entire OTC marketplace.”
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