Ahead of a host of financial reform deadlines in July, the U.S. Commodity Futures Trading Commission will soon begin to finalize rules, possibly with a heightened focus on end-user protections, but a degree of industry uncertainty remains.
"Congress recognized the different levels of risk posed by transactions between financial entities and those that involve nonfinancial entities, as reflected in the nonfinancial end-user exception to clearing," CFTC Chairman Gary Gensler said Feb. 17 in testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs. "Transactions involving nonfinancial entities do not present the same risk to the financial system as those solely between financial entities."
"Consistent with this, proposed rules on margin requirements should focus only on transactions between financial entities rather than those transactions that involve nonfinancial end-users," Gensler said.
The chairman also spoke against end-user margin requirements Feb. 15 in testimony before the House Committee on Financial Services. Responding to concerns by MillerCoors that a 3% margin requirement would drain more than $500 million of liquidity from the company every year, Gensler said, "We are aware and focused on the cost of a six-pack because we also oversee agriculture markets. And I would say our intention is not to have end-user margin requirements apply to an end user such as MillerCoors."
On Feb. 17, Gensler also addressed questions regarding the clearing mandate and margin requirements for swaps entered into prior to the date of enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act. "With respect to the clearing requirement and margin, I believe that the new rules should apply on a prospective basis only as to transactions entered into after the rules take effect," he said.
Having spent the past five months promulgating proposed rules and wading through thousands of industry comments, the CFTC will soon enter its next phase of final rulemaking under the Dodd-Frank Act. Since its first public meeting Oct. 1, 2010, the agency has held 11 such meetings, proposing rules in 26 of the 30 areas established when Dodd-Frank was signed in July 2010.
As of Feb. 15, CFTC staff has had 422 meetings with other market regulators and another 540 meetings with "individuals" to discuss swaps regulation. In that time, the agency has received 2,856 submissions from the public through the e-mail inboxes and 1,258 official comments in response to notices of proposed rulemaking.
Testifying before the House Agriculture Committee, Gensler said Feb. 10 that some of the Dodd-Frank rules will miss their July deadlines and could even spill into the fall. "We are human. Some of these rules will be put in place after July,"
Gensler said the CFTC has reached a "natural pause" in the process, which will allow the agency to continue to collect and review comments from various industry participants.
He said the agency will begin voting on more final rules by the spring and summer and perhaps beyond.
"We can complete the rule-writing through this summer and fall," he said. "We are human. Some of these will slip."
Not all end users convinced on clearing exemption
Noting Dodd-Frank's potential to "unnecessarily impede what is and has been a well-functioning and resilient natural gas market," a group of end users told the commission this week that it could make "three relatively minor modifications or clarifications" to its proposed rule on the use of an end-user exemption on clearing requirements.
In a comment filed Feb. 16, the National Corn Growers Association and the Natural Gas Supply Association said the agency's Notice of Proposed Rulemaking on the end-user exception to mandatory clearing of swaps, which ran in the Federal Register on Dec. 23, 2010, represents "a workable method whereby qualifying swap market participants can elect to use the end-user exception to the Dodd-Frank Act's mandatory clearing requirements."
However, the associations requested clarifications related to authorizing reporting counterparties to rely on electing counterparties' written representations; satisfying financial obligation notice requirement by providing notice of how an electing counterparty meets financial obligations of portfolio of noncleared swaps; and granting board approval on a blanket basis of an electing counterparty's decision not to clear swaps.
"Without these key clarifications, the end user exception is unworkable," Jenny Fordham, NGSA's vice president of markets, said.
Financial community 'coming out of a denial mode'
With the implementation of Dodd-Frank still evolving, much industry uncertainty remains.
For larger financial institutions, this could mean a frenzied attempt to come into compliance with the new rules, all of which should be finalized by July.
"Many firms are either actively starting to thinking about implementation or they are coming out of a denial mode and accepting they will have to start thinking about implementation pretty soon," said Lanny Schwartz, partner at Davis Polk & Wardwell LLP and keynote speaker at "Central Clearing of OTC Derivatives under Dodd-Frank," a Feb. 17 panel discussion in New York presented by Capital Market Consortium.
"Firms of many sizes are going to have a stark choice to make," Schwartz said. "Either they are going to have to massively increase their staff or they are going to have to make strategic and copious use of outside technology, operations, compliance and legal consultants in order to get themselves into compliance."
He said April 15 marks the deadline for provisional registration as a swap dealer, a good way for a company to demonstrate compliance. By July 16, final rules should be in place and according to the Dodd-Frank statute, and by Sept. 16, the various provisions of the swaps regulation should be fully effective.
"The requirements that are coming down the road are many. They are multifaceted. They affect every area of the organization. They need to be thought about in a way that looks at the intricate components of things and that there's a sequencing that needs to go on, that you need to decide certain things like what entities you want to use and what registrations you want use because those will drive many of your remaining decisions," Schwartz said.
CFTC meetings to resume Feb. 24
The agency's next meeting on proposed rulemaking is scheduled for Feb. 24 and will cover anti-disruptive trading practices authority interpretive order; amendments to Commodity Pool Operator and Commodity Trading Advisor regulations; swap data recordkeeping and reporting requirements for pre-enactment and transition swaps; and requirements for processing, clearing and transfer of customer positions.
Meanwhile, the agency's technology advisory committee will meet March 1. The committee, chaired by Commissioner Scott O'Malia, was originally scheduled to meet Jan. 27 but was forced to delay the meeting due to inclement weather. The January meeting was to focus on pre-trade functionality, direct market access controls and costs and technology challenges in implementing the Dodd-Frank Act.
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