House Representatives Critique CFTC's Proposed Margin and Capital Requirements for Uncleared Swaps between Affiliates (with Lofchie Comment)

House Representatives K. Michael Conaway (R-TX) and Collin C. Peterson (D-MN) (the "Representatives") sent a letter to CFTC Chair Timothy G. Massad expressing concern about the CFTC's proposed rules on margin and capital requirements for uncleared swaps between affiliated entities that are part of "global financial institutions."

In the letter, the Representatives focused on the proposed requirement that affiliated counterparties post initial margin with respect to transactions between affiliates that are used to transfer risk within a consolidated business group. The concern is that the proposed requirement would diminish the ability of financial institutions to operate in a cost effective and efficient way. Negative effects on end users include: (i) "reduced liquidity and increasing costs, without significantly reducing the systemic risk posed by financial institutions"; (ii) "additional costs being passed on to a bank's uncleared swap customers, often end-users, without making these trades safer"; (iii) "a new counterparty risk between the affiliates and their third party custodial bank" holding the margin; (iv) a potential "lock up [of] a significant portion of an institution's working capital"; and (v) a potential detriment to "broad efforts to harmonize derivative rules internationally."

The Representatives stated that "requiring affiliates to post initial margin on these [internal risk management] transactions will disincentivize the use of this important tool and push higher transaction costs onto end-users." For that reason, they asked the CFTC to release additional impact assessments of the proposed rule.

Lofchie Comment: Two of the myths that inform Dodd-Frank are these: (i) it is possible to impose costs on the financial system without those costs coming back to operating companies that make use of the tools provided by the financial system and (ii) discouraging the use of derivatives will decrease risk when, in fact, a substantial majority of derivatives employed by commercial end users are intended to reduce or transfer risk.

See: Representatives Conaway and Peterson's Letter to CFTC Chair Massad.