The Commission voted unanimously to approve a rule that preserves the status quo for certain swaps transactions that are transferred as a result of Brexit, but split vigorously along party lines on a rule that eases requirements for swap dealer registration.
By a 3-2 vote, the CFTC adopted a final rule providing for an exclusion from the de minimis threshold for swap dealer registration for swap-dealing activity relating to loans by Insured Depository Institutions (IDIs). According to Chairman J. Christopher Giancarlo, the rule will reduce regulatory burdens and allow end users to hedge their risks, but minority commissioners dissented over concerns that it goes too far in expanding a swap dealer registration exception. At the same open meeting, the CFTC also adopted, by a 5-0 vote, an interim final rule providing relief from certain margin requirements for certain legacy swap transfers in case of a "no-deal Brexit."
Insured Depository Institutions (IDIs). Under Section 1a(49)(a) of the Commodity Exchange Act, an IDI will not be considered a swap dealer to the extent it offers to enter into a swap with a customer in connection with originating a loan with that customer. To implement this provision, the CFTC and SEC jointly adopted an "IDI Swap Dealing Exclusion," contained in paragraph (5) of the swap dealer definition in Rule 1.3, which allows an IDI to exclude certain swaps it enters into with a customer in connection with originating a loan to that customer.
Based on input from market participants and data submitted to swap data repositories, the Commission decided that the existing IDI Swap Dealing Exclusion was overly restrictive and unclear in certain instances, and also limits the ability of IDIs to offer swaps to allow their customers to properly hedge risks associated with bank loans. Accordingly, the Commission issued a proposed rule to amend paragraph (4) of the swap dealer definition, addressing the de minimis exception. The proposal provided that an IDI could assess specified factors and exclude qualifying swaps from the de minimis calculation, regardless of whether the swaps would qualify for the IDI Swap Dealing Exclusion.
Chairman Giancarlo praised the final rule, saying it will reduce regulatory burdens for banks and allow small- and medium-sized commercial borrowers—including manufacturers, home builders, agricultural cooperatives, community hospitals and small municipalities—to conduct prudent risk management that is difficult for them under the current rule. Commissioners Dawn Stump and Brian Quintenz also supported the rule.
Giancarlo noted the following features of the rule:
- The preamble makes clear that the swaps entered into by IDIs must be in connection with and related to the originating loan. For instance, a swap with a borrower entering into it for speculative or investment purposes not related to the loan would not be excepted by the IDI from the de minimis calculation.
- IDIs, as depository institutions, remain subject to prudential supervision for all of their activities, including swaps dealing.
- The rule does not remove the core Dodd-Frank Act swaps requirements of clearing, post-trade reporting, and mandatory trade execution, which Giancarlo fully supports.
- It provides for the Office of the Chief Economist to conduct a study after three years to see how the rule is working and if there is a need for limitations on swap activity.
Dissent. Commissioners Dan Berkowitz and Rostin Behnam dissented from adoption of the rule on both substantive and procedural grounds. Substantively, Berkowitz expressed concern that the rule is a "wolf in sheep’s clothing" that, in the guise of helping smaller banks, opens the door for large banks to undertake an unlimited amount of swap dealing with loan customers without registering as swap dealers. According to Berkowitz, the rule violates the clear intent behind regulating swap dealers, carelessly introduces risk into the financial system by allowing unregulated swap dealing, and could harm smaller banks by allowing larger banks to out-compete them.
"In my view, this amendment drives a truck through the de minimis exception to the swap dealer registration rule by permitting an unlimited quantity of swap dealing by an IDI in connection with loans," said Berkowitz.
Procedurally, Berkowitz said the rule violated a mandate from Congress to define the term "swap dealer" jointly with the SEC. By wholly excluding all IDI De Minimis Provision swaps from counting towards the de minimis threshold, the CFTC is in effect amending the definition of the term "swap dealer." In addition, Berkowitz said the Commission was not informed of, and did not participate in, the substantive contents of any consultation with the SEC in connection with this rulemaking.
As for the final rule’s provision that the CFTC will conduct a study in three years to determine if there is a need for limitation on swaps activity, Berkowitz said this approach was like "opening the barn door today, and in three years, studying where the cows went."
Brexit-related swap transfers. As Berkowitz explained, the interim final rule will maintain the legacy status of swaps that were executed prior to the relevant compliance dates for the CFTC swap margin rule, if those swaps are legally transferred solely as a result of a no-deal Brexit. If the United Kingdom exits the European Union without a negotiated withdrawal agreement, the transfer of these swaps to affiliates outside the U.K. would be needed so the swaps can continue to be properly serviced under E.U. law. Without this rule, new systemic risks could be introduced globally, said Berkowitz.
Berkowitz added that the conditions of the relief—that legacy swap transfers get relief solely if they are undertaken in connection with a no-deal Brexit, and only if the swap terms are not renegotiated—are important limitations to prevent abuse of the flexibility provided by the rule.
MainStory: TopStory CommodityFutures Derivatives ExchangesMarketRegulation FinancialIntermediaries Swaps
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