Revised Swaps Rule Reduces Collateral Demand

Wall Street banks will escape billions of dollars in additional collateral costs after U.S. regulators softened a rule that would have made their derivatives activities much more expensive.

Two agencies approved a final rule on Thursday that will govern how much money financial firms must set aside in derivatives deals. A key change from recent draft versions of the rule—and the focus of months of debate among regulators—cut in half what the companies must post in transactions between their own divisions.

A version proposed last year called for both sides to post collateral when two affiliates of the same firm deal with one another, such as a U.S.-insured bank trading swaps with a U.K. brokerage. The final rule requires that only the brokerage post, cutting collateral demands by tens of billions of dollars across the banking industry. Those costs would still be significantly higher than the collateral they currently set aside.

“Establishing margin requirements for non-cleared swaps is one of the most important reforms of the Dodd-Frank Act,” Federal Deposit Insurance Corp. (FDIC) Chairman Martin Gruenberg said before his agency's vote, noting that changes were made in response to objections raised by the industry.

CFTC Writing Parallel Rule

While the bank regulators' approach is good news for Wall Street, all eyes now turn to the Commodity Futures Trading Commission (CFTC), which is writing a parallel rule. Firms also would need that rule to be softened before claiming a clear victory. Like the CFTC, the Securities and Exchange Commission (SEC) is also drafting a final version of similar requirements to be imposed on separate parts of banks.

CFTC Chairman Timothy Massad said on Wednesday that his agency may have different goals in the rule than the bank regulators overseeing firms that have federal deposit insurance.

“It is important to remember that the entities they regulate are different than ours,” Massad said. “There's a safety and soundness concern there. And that difference is something we're thinking about.”

Senator Elizabeth Warren, a frequent critic of Wall Street, urged the CFTC to follow the lead of the bank regulators and warned against a more lenient rule.

“If the CFTC's rule is weaker than those issued by other federal regulators, it will create opportunities for big banks to game the rules,” Warren, a Massachusetts Democrat, said in a statement before the bank regulators' version was released.

Thursday's approval by the FDIC and the Office of the Comptroller of the Currency also needs to be backed by the Federal Reserve—which hasn't yet announced a meeting date—and other government agencies.

It's difficult to estimate how much is at stake for banks such as JPMorgan Chase & Co. and Morgan Stanley, given the complexity of the market. Even tens of billions in collateral between affiliates is just a slice of about US$315 billion in collateral that would be posted by U.S. firms in all non-cleared swap trades, according to estimates released by the agencies. That estimate is less than half of an earlier figure released by the OCC.

The Clearing House Association, a lobbying group for big banks, said regulators shouldn't have required collateral for the internal trades because the transactions don't increase risk to lenders. Still, the group said the final rule was an improvement from past drafts.

“While one-way posting of margin between affiliates is clearly better than two-way, this rule increases the cost of serving clients and hedging risk while doing nothing to enhance the safety and soundness of the organization,” Greg Baer, president of the Clearing House Association, said in a statement after the rule was approved.

The rule is one of the last major requirements stemming from U.S. regulators' swaps-market overhaul, which began after largely unregulated credit-default trades helped fuel the 2008 market meltdown. The 2010 Dodd-Frank Act sought to increase the amount of collateral backing swaps in an effort to reduce broader systemic risks stemming from a default. The law called for most swaps to be guaranteed at third-party clearinghouses that stand between buyers and sellers. Still, many trades in the multi-trillion global swap market remain uncleared.

In other ways the rule has been eased from the earlier proposal, the new requirement will be phased in over four years, starting Sept. 1, 2016, for the biggest firms—with no retroactive demand. It also expands what type of assets may be used for collateral.

A related rule, also conditionally completed on Thursday, exempts commercial energy and agricultural firms from the collateral requirements.

Other government officials have objected to easing the earlier draft—most prominently FDIC Vice Chairman Thomas Hoenig. He said in a statement that the financial system would have been “best served” by demanding collateral from both sides of every internal transaction, but that “much is accomplished with the requirement that the insured bank collect margin.”

–With assistance from Cheyenne Hopkins in Washington.

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