Dodd-Frank margin intent delivers end-users a blow, despite reprieve

Senator's letter fails to assuage end-user concerns over non-cleared swaps

Corporate end-users of derivatives will still face substantial costs in non-cleared swaps, despite being given a reprieve by key senators who maintain end-users will not be directly subjected to burdensome margin requirements.

The chairman of the Senate Banking Committee, Christopher Dodd, and chairman of the Senate Agriculture Committee, Blanche Lincoln, said the Dodd-Frank bill only gives regulators the ability to impose margin requirements on swap dealers and major swap participants in non-cleared swaps, not on end-users. Their comments were published in a letter on June 30 to Barney Frank, chairman of the House Financial Services Committee, and Colin Peterson, chairman of the House Committee on Agriculture, seeking to provide additional background on the legislative intent of the margin provisions in the Dodd-Frank bill.

"Regulators are charged with establishing rules for the capital requirements, as well as the margin requirements for all uncleared trades, but the rules may not be set in a way that requires the imposition of margin requirements on the end-user side of a lawful transaction. In the case where a swap dealer enters into an uncleared swap with the end-user, margin on the dealer side of the transaction should reflect the counterparty credit risk of the transaction," states the letter.

The letter was written in response to industry outcry over the language contained in the bill. Industry critics maintained it gave authority to regulators to impose margin requirements on end-users in non-cleared swaps, after a provision that unequivocally exempted end-users from margining was omitted during the conference process on Friday June 25. The clause was removed to avoid "redundancy and streamline the regulatory framework", according to Dodd and Lincoln.

However, corporates argue that even if end-users are not subject to margining requirements, the fact the counterparty to a trade will be subject is a major concern - corporates fear that if a dealer is the sole party required to margin a non-cleared swap, the cost will ultimately be passed onto the end-user.

Margin should not only not be imposed directly on end users, but also, rules should exempt any uncleared swap in which an end user is party from the bill’s margin requirements

"End-users are concerned not only about margin being directly applied to them, but also about margin being applied on their counterparties. This concern acknowledges that if margin were imposed on the counterparties to end-users, end-users would ultimately bear the cost and would need to pass that cost onto consumers. Margin should not only not be imposed directly on end-users, but also, rules should exempt any uncleared swap in which an end-user is party from the bill's margin requirements," says Tom Deas, chairman of the National Association of Corporate Treasurers in Philadelphia.

The sentiment is echoed by an industry lobbyist, who says it is an indirect imposition of margin on end-users rather than a direct one. "It is very worrying for all concerned," he says.

Dodd and Lincoln do encourage regulators to establish margin requirements for such swaps in a manner that is consistent with congressional intent to protect end-users from burdensome costs. However, the requirements will now be decided by the Commodity Futures Trading Commission and the Securities and Exchange Commission.

According to an industry source, congressional staffers charged with drafting the bill admitted in private that the original exemption omission was an oversight. However, the chance to rectify the omission was missed on June 29, after the conference committee reconvened in dramatic circumstances.

The committee called an emergency meeting to amend the bill, in order to secure key votes to ensure its passage, after senator Scott Brown voiced concern over the $19 billion bank tax. But other amendments were tabled too, including one that would re-admit the end-user exemption on margining - the amendment failed after the votes were tied 6-6. Christopher Dodd said Democrats agreed with the substance of the issue and, if need be, it could be remedied in a subsequent bill.

The bill was passed in the House on June 30 and is expected to face a vote in the Senate in mid-July, before being signed into law.