Wall Street May Save Billions on Swaps

A quarrel among regulators could add up to billions in savings for Wall Street banks.

At stake is a proposed rule that has dragged on for years that could require firms like JPMorgan Chase & Co. and Morgan Stanley to set aside tens of billions of dollars in collateral when trading swaps with their own affiliates. Now, a last-ditch effort by bank lobbyists has helped spur some regulators to second-guess how strict they should be, according to three people familiar with the discussions.

The Office of the Comptroller of the Currency (OCC), which regulates some of the largest banks that deal in swaps, is leaning toward insisting only an affiliate post collateral to the bank, said the people, who requested anonymity because the final rule isn't yet public. The Federal Deposit Insurance Corp. (FDIC) has backed a version of the rule proposed in September, demanding both a bank and its affiliate put up collateral, the people said.

Swaps trading—when it was largely unregulated—amplified the financial crisis seven years ago. An aggressive collateral rule would help prevent affiliates from collapsing and leaving taxpayers on the hook, Thomas Hoenig, vice chairman of the FDIC, said in an interview. Banks also are hiding behind the complexity of the rule to say it puts them at a competitive disadvantage with foreign rivals, he said.

“It's never a competitive disadvantage to operate in a more stable and robust financial system, as the banks that entered the financial crisis with the lowest capital levels quickly discovered,” Hoenig said.

Transfer Risk

Financial firms have argued they shouldn't be required to put up collateral in swaps transactions with their own divisions, which they say they do to hedge risks. For example, under the version of the rule the FDIC has advocated for, JPMorgan would be required to post collateral against a trade of non-cleared swaps with its U.K. brokerage, and the U.K. brokerage would have to post collateral to JPMorgan as well. Andrew Gray, a JPMorgan spokesman, declined to comment.

The firms typically do these trades to transfer risk from their affiliates to their deposit-backed banks, where they enjoy better borrowing rates. Current practice doesn't call for collateral in these transactions.

The FDIC's Hoenig said trades with overseas units can expose banks to serious risks. If an affiliate implodes and drags down the U.S. holding company, the FDIC would have to prop up the mess—keeping depositors' money safe and using Dodd-Frank Act powers to rebuild a healthy version of the parent company. If banks are required to post collateral to their units, it reduces the likelihood that the FDIC would have to intervene in a crisis, he said.

The biggest swaps dealers include JPMorgan, Morgan Stanley, Goldman Sachs Group Inc., Citigroup Inc., and Bank of America Corp. It's difficult to estimate how much money is at stake for them given the complexity of the market. If the final rule is less stringent than the September proposal, they could reduce the collateral they have to hold by tens of billions. That's a slice of about $644 billion in collateral that would be held by banks in non-cleared swap trades, according to preliminary OCC estimates.

Forcing the banks to hold extra collateral would hurt liquidity, said Adam Gilbert, a former JPMorgan executive who now advises on financial regulation at PricewaterhouseCoopers LLP. Firms may find it so costly they decide not to do the internal transactions at all, he said.

'Question Marks'

Trade groups representing Wall Street banks—the Clearing House Association, American Bankers Association and Securities Industry, and Financial Markets Association—have fought to shield banks and their affiliates from the demand. In a June letter to regulators, they said if their members aren't exempt for all interaffiliate swaps trades, then only a limited number of units should have to set aside funds.

Officials at the Commodity Futures Trading Commission (CFTC), which along with the Securities and Exchange Commission (SEC) is supposed to provide a parallel version of the bank regulators' rule, have also expressed concerns. J. Christopher Giancarlo, a Republican CFTC commissioner, has said the requirement would drive up banks' costs for trading, which would then be passed to clients.

“I still think there are some question marks,” Mark Wetjen, a Democrat on the CFTC, said in an interview.

Morgan Stanley and other bank executives pushed for an exemption from the CFTC at a public meeting at the agency's headquarters in May. The executives said the requirement would hurt their ability to manage risks. Mark Lake, a spokesman for Morgan Stanley, declined further comment.

The OCC “has always supported” making banks collect collateral from uninsured affiliates, said Bryan Hubbard, an OCC spokesman, who declined to comment on whether the agency wanted the banks to also post collateral to their units. Spokesmen for the FDIC, CFTC, and Federal Reserve—the other banking agency working on the rule—declined to comment on the debate.

Lawmakers have also been involved in the swaps battle. Earlier this year, the House Agriculture Committee, which oversees the CFTC, drafted broad derivatives legislation.

“Interaffiliate swaps are an important risk management tool,” Representative Randy Neugebauer, a Texas Republican on the committee, said in a emailed statement.

Debate on the legislation quickly turned partisan. Republicans struggled to win support for provisions easing swaps rules from Democrats, who said the bill would open up loopholes for Wall Street to exploit. Staff for Representative K. Michael Conaway, the Texas Republican who serves as chairman of the agriculture panel, reached out to industry lobbyists asking for their help wooing Democrats.

“We'd like for it to be really bipartisan,” a Conaway staff member wrote in an email obtained by Bloomberg News.

In the end, Conaway and Neugebauer decided the agriculture bill just wasn't the right place to deal with the issue, according to their spokesmen. With legislation on hold, the debate remains in regulators' hands.

–With assistance from Dakin Campbell in New York.

Complete your profile to continue reading and get FREE access to Treasury & Risk, part of your ALM digital membership.

Your access to unlimited Treasury & Risk content isn’t changing.
Once you are an ALM digital member, you’ll receive:

Thought leadership on regulatory changes, economic trends, corporate success stories, and tactical solutions for treasurers, CFOs, risk managers, controllers, and other finance professionals
Informative weekly newsletter featuring news, analysis, real-world case studies, and other critical content
Educational webcasts, white papers, and ebooks from industry thought leaders
Critical coverage of the employee benefits and financial advisory markets on our other ALM sites, PropertyCasualty360 and ThinkAdvisor