The Warner-Warren Derivatives Reform Bill (July 6)

Mike & Co.,

Last week, Sens. Warner and Warren, along with Rep. Elijah Cummings, announced the Derivatives Oversight and Taxpayer Protection Act (S. 3188, H.R. 5592), , a bill to strengthen the CFTC’s power to regulate derivatives transactions and increase the agency’s budget by changing the source of its appropriations.

Yesterday, the bill’s three sponsors followed up by releasing open letters to two systemically important derivatives clearing organizations, requesting information on those firms’ orderly resolution documents.

More on the bill, its impact, and its broader role and significance below.

Best,

Dana

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The bill’s announcement drew notice in part because Sen. Warner signed on as an original cosponsor.  Sen. Warren is not a stranger to bringing together varied groups of lawmakers to get things done, but Warner’s presence speaks to the importance of this bill as a blueprint for Democrats’ future regulatory plans.

The derivatives market is massive – with an estimated nominal value of $400 trillion in the United States alone.  Not only is its size impressive, but it can make  derivative instruments a major source of volatility in the market.

Economists have pointed to reckless derivatives trading on mortgages and related products as a major contributing factor to the 2008 crisis.  To prevent that from happening again, Dodd-Frank endowed the CFTC with broad new powers to regulate and oversee derivatives trading but left the funding for this critical task up to Congressional appropriations.  DFA also left open certain loopholes for derivatives traders and left it up to the CFTC to determine how it calculated capital requirements.

What’s in it? 

Broadening CFTC Oversight

  •  Updating the CFTC’s enforcement authority so that the agency can impose meaningful civil penalties on firms that break the law and deter misconduct by repeat offenders.
  •  Closing the cross-border loophole, which currently allows big financial firms with operations abroad to circumvent many key CFTC requirements.
  •  Ending the exemption of certain foreign exchange swaps from CFTC jurisdiction, ensuring adequate oversight of a key derivatives market.
  •  Banning the use of closeout netting for purposes of calculating minimum capital requirements.
  •  Strengthening the CFTC’s margin rule by requiring the posting of initial margin in inter-affiliate swaps.
  •  Authorizes the CFTC to collect fees from the entities it regulates.  While the agency will still be subject to the appropriations process, having a pool of funds to point lawmakers toward may help increase the CFTC budget in the long run.

What’s Not? 

A provision reinstating the swaps operations push-out mandate from DFA was removed as part of a deal to secure Sen. Warner’s support.  The mandate was originally suspended during the 2014 cromnibus negotiations.  That may not please progressive Democrats.

Is the Bill DOA? 

As long as the GOP controls Congress.  The largest Wall Street banks account for 95 percent of the U.S. market for derivatives and can be expected to fight tooth and nail to prevent any increase in their regulatory requirements.  Such strong opposition, coupled with the relatively scarce few days left in the current Congress, add up to a dim future for the Warner-Warren bill in 2016.

But bills like this can do a great deal of good simply by being introduced, open a conversation about one of the most significant and volatile financial instruments, and setting an agenda for reform.  Importantly, they offer a valuable political opportunity for candidates seeking the mantle of reform to stump on.

Derivatives and Systemic Risk 

As part of the bill roll-out, Senators Warner and Warren and Rep Cummings wrote open letters to two major derivatives clearinghouses – CME Group and Intercontinental Exchange – seeking information about their recovery and resolution plans.   The two companies are arguably systemically important derivative clearing organizations, and as such could be considered obligated to prepare resolution plans “that would be implemented as needed to guide their orderly failure.”

The letter requests the firms’ final recovery and resolution plans, and specific information on whether the plans have been reviewed by federal regulators, which events trigger the plans’ execution, how clearing services are isolated from other activities, and to what extent the firms have addressed the systemic risks they may face.

The Bill in the Campaign Context

Even though Congress won’t move on the Warner-Warren bill in 2016, it is a stand out proposal for continuing the work that the DFA started.  It reinforces the HRC mantra of defending and building upon Dodd-Frank in a manner that supports middle-America and prevents a repeat of the 2008 crisis.

As Senator from New York, HRC called for greater oversight on derivatives trading in the early days of the financial crisis.  In a November 2007 speech, she said “We need to start addressing the risks posed by derivatives and other complex financial products … derivatives and products like them are posing real risks to families, as Wall Street writes down tens of billions of dollars in investments.”

Per the campaign:  “HRC and the Democratic Party believe that we need to take on excessive risks in the financial system and hold people accountable for financial misdeeds…. we Democrats agree that we need to build on and strengthen Dodd-Frank and go further.

Bottom line:  if you believe in the above, there’s almost no good reason not to support or endorse this bill.

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