From the April 2011 issue of Exchange magazine: www.afponline.org/exchange
Late last month, Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler reiterated his intent to respect an important end-user exemption that was inserted in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
The legislation that would overhaul U.S. financial services regulation with new controls on large and interconnected financial firms, tougher capital and operating standards for banks, and a new regime for the regulation of derivatives, was signed into law in July 2010. It also required the vast majority of all derivatives trading be executed on a public exchange as opposed to between banks and their customers as many contracts are currently structured. The bill also dictated that non-financial company end-users, along with their pension plans and captive finance affiliates, were generally exempted from new regulations on derivatives and would be allowed to continue to use over-the-counter derivatives to manage risk, without posting margin or clearing the transactions. The legislation provided the U.S. Securities and Exchange Commission (SEC) and CFTC with authority to regulate over-the-counter derivatives so that irresponsible practices and excessive risk-taking can no longer escape regulatory oversight.
Since Dodd-Frank was signed into law, regulators at both the SEC and the CFTC have begun issuing rules to guide these regulations and clarify how this market will be governed. With the new regulatory authority in a previously unregulated market, comes great anticipation about specific questions on exactly how implementation will ultimately be executed. Parties involved in the purchase of derivatives have voiced great concerns that over burdensome regulations would make the use of these tools prohibitively more expensive and as a result, have a profound derogatory impact on their bottom line and operations.
In a public speech made to a large group in Washington, D.C., Chairman Gensler acknowledged these concerns and said that the agency will adhere to Congressional intent when proposing rules for margin on derivatives contracts entered into by commercial “end-users” and let such entities and their counterparties negotiate their own details.
Chairman Gensler observed that lawmakers were clear in 2010 when writing Dodd-Frank and were explicitly clear about giving commercial end-users of derivatives a choice of whether to clear their transactions. Most end-users, according to Gensler, probably would choose not to clear and avoid the added expense, which would include having to put up margin. Currently, end-user counterparties typically do not require margin from their end-user partners, instead crafting other ways to guarantee their transactions that do not require a capital outlay from end-users. Although Congress was clear about the clearing exception for end-users, many end-users still worried that the CFTC would require them to post margin when executing their transactions bilaterally with dealers.
During the debate of the Dodd-Frank legislation, AFP voiced its concerns that the reform efforts focused on the much publicized and more exotic and speculative uses of derivatives and, as an unintended result, businesses that used derivatives responsibly to contain costs and manage risks associated with their ongoing business operations, as well as their shareholders, were at risk of losing the benefit of these risk management strategies. AFP argued that derivative products are essential risk management tools that financial professionals rely on to help mitigate volatility in the prices of the raw materials, goods and services they buy and sell.
Further, AFP provided research and data that supported AFP’s claims that derivatives are used to minimize the risks to profitability from transacting business in foreign currencies, in addition to reducing the cost of capital that a business must generate to sustain and grow their operations. Thankfully, legislators in the House and Senate heard AFP members’ concerns and included an end-user exemption in the final bill.
Observing that Congress gave end-users a choice about whether to clear in the bill, Gensler said, “That’s the approach we will take at the CFTC [regarding] margin—that commercial end-users would again have a choice in their relationships between themselves and dealers as to whether they have any margin arrangements.”
The CFTC is now receiving public comments on many of the rules that they have written to regulate derivatives and AFP is committed to providing comments where appropriate and necessary.
AFP applauds the efforts of the CFTC to bring transparency and stability to the OTC derivatives market, prevent excessive speculation, and secure derivatives markets. AFP’s membership needs to preserve the use of interest rate swaps, foreign exchange swaps and other OTC derivatives as essential tools for prudent risk management. AFP will continue to advocate for the preservation of the end-user exemption and will work with lawmakers and regulators to ensure an explicit exemption in all regulations.
Jeanine Arnett is AFP's director of government relations. Contact firstname.lastname@example.org