Democrats Introduce Bill to Increase Oversight of Derivatives (with Delta Strategy Group Summary)
Commentary by Steven Lofchie
Senators Elizabeth Warren (D-MA), Mark Warner (D-VA) and Representative Elijah Cummings (D-MD) introduced the Derivatives Oversight and Taxpayer Protection Act. The bill amends the CEA to strengthen federal oversight of derivatives.
The proposed legislation would:
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direct the CFTC to collect user fees from financial firms in order to cover its budget, an action intended to help the CFTC manage its increased oversight responsibilities under the Dodd-Frank Act;
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enhance penalties for violations from $140,000 to $1 million for individuals, and from $140,000 to $10 million for other entities, while providing an alternative measure that triples (i) either the monetary gain of the violator or the losses caused by such violation, and (ii) the amount of any penalty for repeat offenders;
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close the "cross-border loophole" in order to prevent large financial firms that maintain operations abroad from circumventing many key CFTC requirements;
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end certain foreign exchange swaps' exemption from CFTC jurisdiction, as provided currently by the Secretary of the U.S. Treasury Department under the authority of the Dodd-Frank Act;
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strengthen the CFTC margin rule by requiring initial margin in inter-affiliate swaps to be posted;
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ban the use of closeout netting to calculate minimum capital requirements; and
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require the CFTC and other regulators to issue reports that address concerns about derivatives clearinghouses.
In an accompanying press release, Senator Warren emphasized the importance of the bill's preventative measures:
The only way to make sure that derivatives can never lead to a financial crisis and taxpayer bailouts again is to put in place clearer rules and stronger oversight. Otherwise, big financial firms will be able to rake in billions when things go well, then come back to taxpayers with their hands out when things come crashing down. That might be just fine for Republicans and their allies on Wall Street, but Democrats are standing together to make sure that never happens again.
Commentary
The proposed bill is a politically charged document. Most of it cannot withstand economic scrutiny. At a minimum, the legislators should (i) quantify the costs of the proposal and (ii) discuss the effect that raising financial transaction costs for no economic reason will have on business activities in the United States.
Consider the proposed requirement that closeout netting cannot be used to determine capital requirements: if Firm A owed Firm B five dollars on one trade and Firm B owed Firm A five dollars on another – which would mean that the two firms owed each other nothing – then the bill would require each firm to take capital charges, as if each had five-dollar obligations to the other. There is no apparent logic to that measure, nor is it likely that there is any hidden logic.
Many derivatives essentially are credit transactions. If proponents of this bill are opposed to credit transactions in the form of derivatives, then it seems fair to ask them about their positions on credit transactions generally: Should banks, particularly large banks, be banned from lending money at all, since such credit activities could allow banks to make money – perhaps billions – and then return to the Senate for redress when lenders do not repay them? Should U.S. banks be prohibited from lending money outside of the United States or to non-U.S. persons?
One meaningful proposal in the bill is the requirement that regulators conduct studies of clearinghouse risks. This proposal might be made even better if any study of clearinghouse risk would be led by independent analysts rather than the regulators and government officials who had asserted vociferously in the past that clearinghouses would reduce risk significantly. Officials have too high a stake in clearinghouses to resist downplaying the risks that they themselves have created. Perhaps someone like Professor Craig Pirrong might be selected, since he was one of the first to point out that these risks existed. See, e.g., Streetwise Professor Warns That CCP Mandates Are Creating Liquidity Risk and Systemic Stress.
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