Non-banks notch win in long-running derivatives battle
NEW YORK (Reuters) - A group of small brokerages and large commodities companies have convinced lawmakers to tweak a rule they say would have made derivatives trading more expensive for them and sent more business to Wall Street banks that already dominate the market.
Companies including INTL FCStone Inc, Nomura Holdings Inc, Cargill Inc and Royal Dutch Shell Plc lobbied a congressional committee to change a rule proposed by the U.S. Commodities Futures Trading Commission (CFTC) on how much capital they must hold against derivatives trades as dealers, people familiar with the matter told Reuters. Cargill and Shell have derivatives trading arms.
Under proposed CFTC rules, these companies would be required to hold more capital against certain derivatives trades - also known as "swaps" trades - than banks. That is because the CFTC rules, created as part of the 2010 Dodd-Frank financial reform law, allow banks to calculate capital needs using their own proprietary models but force non-bank swaps dealers to use standardized models.
By using their own models, big Wall Street banks can, for instance, minimize their capital requirements by combining the potential risk of two trading positions that offset one another, rather than holding capital against the risk of each one going sour. Non-bank dealers complained that the CFTC's proposal did not allow them to perform such "netting" of offsetting trades.
The brokerages and commodities companies lobbied the House Agriculture Committee after they failed to gain traction with the CFTC.
The committee has drafted a bill that will provide funding for the CFTC and has inserted the tweak requested by these companies in legislation. The bill still needs to go through the rest of the legislative process before it is passed, but if successful it will allow non-bank dealers to also use proprietary capital models.
Broadly, the CFTC's mandate in proposing derivatives rules is to reduce systemic shocks in the $690 trillion over-the-counter derivatives market, like the one posed by the near-collapse in 2008 of swaps-trading insurance group American International Group Inc. Proponents of the change said it would not interfere with that mandate, but would make the rules fair for all market participants.
"The provision would simply level the playing field between bank and non-bank swap dealers," said Mark Klein, a spokesman for Cargill.
In announcing the proposed legislation, the committee said the change "corrects an illogical and unworkable capital requirement" that would have pushed non-bank dealers out of the derivatives market, making it less competitive for banks. Of the 84 registered swap dealers, less than a quarter are non-bank entities.
The non-bank dealers' effort to change a proposed rule is the latest example of how, nearly four years after Dodd-Frank passed, companies are still scrambling to blunt the impact of new regulations on their businesses.
In this instance, the stakes are particularly high for the small, non-bank brokers. At last year's hearing, FCStone Chief Financial Officer William Dunaway argued that the CFTC's proposed rules would force his company to hold "hundreds of times more" capital than a bank for an identical book of trades.
Small changes to the way capital charges are calculated could lead a dealer to hold anywhere from $3.9 million to $536.7 million worth of capital against the same trade, according to evidence submitted by FCStone to the Agriculture Committee.
"If left unchanged, these capital rules will eventually cause non-bank swap dealers to exit the business," Dunaway said at the hearing.
FCStone does not disclose how much of its trading revenue is related to derivatives.
The lobbying effort also offers a window into the strange bedfellows that the years-long derivatives lobbying effort has created. In previous instances, big companies have sided with banks on derivatives rules, fearful that changes would make trading more expensive for them as counterparties.
For example, the Coalition for Derivatives End Users, which includes Cargill and Shell among many others, lobbied alongside banks as Dodd-Frank was being written and in its aftermath to ease some derivatives reform proposals like higher margin requirements. The Agriculture Committee's proposed legislation on Tuesday - titled "The Customer Protection and End-User Relief Act" - also addresses some of those concerns for customers.
Corporations just want to make sure their trading costs are contained and are indifferent about who is on their side, said one lawyer in Washington who has worked on derivatives reform.
"Sometimes issues involving non-bank dealers overlap with end-user issues and in those cases, they can be working with the banks and against the banks at the same time," the lawyer said.