The Senate late Thursday passed historic, broad-based legislation that calls for a sweeping overhaul of the nation’s financial regulatory system, including regulation of the over-the-counter (OTC) derivatives market for the first time.
The bill cleared the Senate by a partisan vote of 59-39, with four Republicans voting in favor of the measure, which contains derivatives provisions that are both supported and opposed by oil and natural gas producers, industrial users and manufacturers. The Senate and House will now move to reconcile their respective bills in conference (S. 3217, HR 4173), a process that could get rough as Wall Street lobbyists make a last ditch attempt to derail more stringent parts of the legislation. The House passed its financial regulatory reform bill in December (see NGI, Dec. 14, 2009).
“There’s no doubt that during that time [conference], the financial industry and their lobbyists will keep on fighting” to weaken the reform bill, said President Obama Thursday following the successful cloture vote, which cleared the way for a final vote on the Senate bill. “I will ensure that we arrive at a final product that is both effective and responsible — one that holds Wall Street to high standards of accountability and secures financial stability.”
Senate passage of the 1,400-page financial regulatory reform bill was a major victory for Obama, who, with Senate leadership, has been working toward this goal since the credit and financial meltdown in late 2008.
Of key interest to the energy industry, the bill seeks to curb commodities market speculation by forcing OTC derivatives trades onto regulated exchanges and clearinghouses. It provides an exemption to the trading/clearing requirement for large commercial traders who use derivatives to hedge the risk associated with trading of physical products.
Derivatives are financial instruments whose price depends upon or is derived from one or more assets, such as energy. Their value is determined by fluctuations in the underlying value. They are mostly used to hedge commercial risk, but also can be used for speculative purposes. Some derivatives, such as agricultural commodities, are already traded on regulated exchanges. But OTC derivatives are traded off-exchange and out of the purview of the Commodity Futures Trading Commission (CFTC). Misuse of derivatives was blamed in part for the financial crisis of 2008.
Specifically, the exemptions would apply to end-users (and their affiliates) who use OTC derivatives to hedge the risk associated with commodities, as well as the manufacturers of goods, and they would apply to a broad array of commodities, including oil, natural gas, electricity and coal.
The derivatives portion of the legislation, which was largely drafted by Senate Agriculture Committee Chair Blanche Lincoln (D-AR), retains a provision that would require big banks, such as JPMorgan Chase, Goldman Sachs and Citibank, to either shed or spin off their lucrative derivatives trading desks (see NGI, April 19). This provision was widely opposed by Republicans, who were unsuccessful in a concerted campaign to strike it.
The bill would refuse the banks access to Federal Deposit Insurance Corp. (FDIC) guarantees and the Federal Reserve discount window in connection with their trading of derivatives. This language could be changed in the House-Senate conference.
“I was proud to craft the bill’s strong derivatives title. My legislation brings a $600 trillion market into the light of day and ends the days of Wall Street’s backroom deals…I will continue to stand up to Wall Street lobbyists and special interest groups to advocate for these reforms as we work to get this bill signed into law,” said Lincoln, who faces a tough run-off election in early June.
A much-anticipated manager’s amendment to strike Lincoln’s controversial provision was not offered after Senate Banking Committee Chairman Christopher Dodd (D-CT), the chief architect of the financial regulatory reform bill, and Sen. Richard Shelby of Alabama, the ranking Republican on the banking panel, failed to reach a deal, CQ Today reported..
Federal Reserve Chairman Ben Bernanke, FDIC Chairman Sheila Bair, Comptroller of the Currency John Dugan and Paul V. Volcker, former Federal Reserve chairman and White House economic policy adviser, spoke out strongly against Lincoln’s proposal.
The provision also has raised concerns among the bona fide hedgers of commercial risk. “Our concern is it [the language] would reduce the number of counterparties with which we could trade” and the availability of capital, said Susan Ginsberg, regulatory vice president of the Independent Petroleum Association of America.
It’s estimated that it would cost financial institutions approximately $250 billion to set up separate swap desks under Lincoln’s provision, according to Sen. Judd Gregg (R-NH).
Sen. Robert Corker (R-TN) said the bill raises “great questions” about capital being tied up as a result of the major banks being required to set up separate derivatives desks. He further noted that the measure would add $17-23 billion to the national debt.
The legislation also cuts off a drive by the CFTC to claim sole jurisdiction over natural gas and power transactions. The amendment passed by voice vote on the Senate floor Tuesday night, preserving the existing authority of individual states and the Federal Energy Regulatory Commission in the oversight of the natural gas and power markets.
A broad alliance of co-sponsors, including Sens. Jeff Bingaman, (D-NM), Lisa Murkowski (R-AK) and Senate Majority Leader Harry Reid (D-NV) signed on to the amendment to preserve FERC’s Federal Power Act and Natural Gas Act authority to ensure just and reasonable rates to natural gas and electric power utility customers.
“The Senate tonight took a strong, principled stand in support of consumer protection,” Bingaman said. “Let’s hope this safeguard doesn’t get tampered with in conference.”
The bill specifies that the jurisdiction of the CFTC over futures or derivative contracts shall not be construed to supersede or limit FERC’s authority or that of a state regulatory agency over rates and charges for natural gas and electricity. Currently the CFTC mainly has had jurisdiction over the paper market while FERC has minded the physical market for natural gas, including pipelines and the electric power transmission system. The state regulatory agencies regulate electric utility rates to consumers.
The split jurisdiction has led to some clashes in the past, notably over the prosecution of the failed hedge fund Amaranth Advisors LLC, which involved large natural gas futures market trades (CFTC jurisdiction) that were said to impact the physical market (FERC jurisdiction). In the end both agencies carried out legal action against the company and its principal (see NGI, Sept. 17, 2007).
The CFTC has lobbied to extend its jurisdiction, particularly over the regional transmission organizations in the power market. The agency has warned that potential regulatory loopholes could allow cases of market manipulation to slip through the cracks.
FERC Chairman Jon Wellinghoff and his immediate predecessor, Joseph Kelliher recently told a congressional committee that requiring the two agencies to agree on a memorandum of understanding would not end the dispute (see NGI, March 15). “I think Congress decides jurisdiction, not agencies, and that FERC and CFTC have an honest disagreement on interpreting the law…at this point, only courts or Congress can resolve the dispute between the agencies,” Kelliher said.
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