Non-banks notch win in long-running derivatives battle

Reuters - UK Focus

(Adds attribution in second paragraph, first name and title forDunaway, background on CFTC (Taiwan OTC: 1586.TWO - news) 's swaps reform mandate)

By Lauren Tara LaCapra

NEW YORK (Frankfurt: HX6.F - news) , April 9 (Reuters) - A group of small brokeragesand large commodities companies have convinced lawmakers totweak a rule they say would have made derivatives trading moreexpensive for them and sent more business to Wall Street banksthat already dominate the market.

Companies including INTL FCStone Inc (NasdaqGS: INTL - news) , NomuraHoldings Inc, Cargill Inc and Royal DutchShell Plc lobbied a congressional committee to change arule proposed by the U.S. Commodities Futures Trading Commission(CFTC) on how much capital they must hold against derivativestrades as dealers, people familiar with the matter told Reuters.Cargill and Shell (LSE: RDSB.L - news) have derivatives trading arms.

Under proposed CFTC rules, these companies would be requiredto hold more capital against certain derivatives trades - alsoknown as "swaps" trades - than banks. That is because the CFTCrules, created as part of the 2010 Dodd-Frank financial reformlaw, allow banks to calculate capital needs using their ownproprietary models but force non-bank swaps dealers to usestandardized models.

By using their own models, big Wall Street banks can, forinstance, minimize their capital requirements by combining thepotential risk of two trading positions that offset one another,rather than holding capital against the risk of each one goingsour. Non-bank dealers complained that the CFTC's proposal didnot allow them to perform such "netting" of offsetting trades.

The brokerages and commodities companies lobbied the HouseAgriculture Committee after they failed to gain traction withthe CFTC.

The committee has drafted a bill that will provide fundingfor the CFTC and has inserted the tweak requested by thesecompanies in legislation. The bill still needs to go through therest of the legislative process before it is passed, but ifsuccessful it will allow non-bank dealers to also useproprietary capital models.

Broadly, the CFTC's mandate in proposing derivatives rulesis to reduce systemic shocks in the $690 trillionover-the-counter derivatives market, like the one posed by thenear-collapse in 2008 of swaps-trading insurance group AmericanInternational Group Inc. Proponents of the change saidit would not interfere with that mandate, but would make therules fair for all market participants.

"The provision would simply level the playing field betweenbank and non-bank swap dealers," said Mark Klein, a spokesmanfor Cargill.

In announcing the proposed legislation, the committee saidthe change "corrects an illogical and unworkable capitalrequirement" that would have pushed non-bank dealers out of thederivatives market, making it less competitive for banks. Of the84 registered swap dealers, less than a quarter are non-bankentities.

The non-bank dealers' effort to change a proposed rule isthe latest example of how, nearly four years after Dodd-Frankpassed, companies are still scrambling to blunt the impact ofnew regulations on their businesses.

In this instance, the stakes are particularly high for thesmall, non-bank brokers. At last year's hearing, FCStone ChiefFinancial Officer William Dunaway argued that the CFTC'sproposed rules would force his company to hold "hundreds oftimes more" capital than a bank for an identical book of trades.

Small changes to the way capital charges are calculatedcould lead a dealer to hold anywhere from $3.9 million to $536.7million worth of capital against the same trade, according toevidence submitted by FCStone to the Agriculture Committee.

"If left unchanged, these capital rules will eventuallycause non-bank swap dealers to exit the business," Dunaway saidat the hearing.

FCStone does not disclose how much of its trading revenue isrelated to derivatives.

The lobbying effort also offers a window into the strangebedfellows that the years-long derivatives lobbying effort hascreated. In previous instances, big companies have sided withbanks on derivatives rules, fearful that changes would maketrading more expensive for them as counterparties.

For example, the Coalition for Derivatives End Users, whichincludes Cargill and Shell among many others, lobbied alongsidebanks as Dodd-Frank was being written and in its aftermath toease some derivatives reform proposals like higher marginrequirements. The Agriculture Committee's proposed legislationon Tuesday - titled "The Customer Protection and End-User ReliefAct (KOSDAQ: 131400.KQ - news) " - also addresses some of those concerns for customers.

Corporations just want to make sure their trading costs arecontained and are indifferent about who is on their side, saidone lawyer in Washington who has worked on derivatives reform.

"Sometimes issues involving non-bank dealers overlap withend-user issues and in those cases, they can be working with thebanks and against the banks at the same time," the lawyer said. (Editing by Paritosh Bansal and Richard Chang)

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