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Banking Industry Urges SEC and CFTC to Include Small Banks within Dodd-Frank Derivatives End-User Exemption

By Jim Hamilton

In a joint letter to the SEC and CFTC, the American Bankers Association urged the Commissions to include an exemption for small banks in their final rules on the end-user exception to mandatory swaps clearing. With regard to the notification requirements for end users, the ABA urged the agencies not to require public dissemination of the information since it would reveal proprietary business information and could cause competitive harm.

The Dodd-Frank Act mandates new clearing requirements for swaps but provides an exception for end users if they use these derivatives to hedge or mitigate commercial risk. Dodd-Frank requires both Commissions to consider whether to exempt small banks from the new mandatory swaps clearing requirements. Absent an exemption, noted the ABA, even small banks would be deemed financial entities, which would not be eligible to be considered as end users. Thus, unless the Commissions exercise their exemptive authority, such banks will have to comply with the new clearing requirements even if they use swaps to hedge commercial risk.

The statutory mandate is for the Commissions to consider an exemption for small banks, including depository institutions with total assets of $10 billion or less. But, noted the ABA, Dodd-Frank gives the SEC and CFTC the flexibility to consider exempting institutions with total assets higher than the $10 billion threshold, and they should do so. The ABA urged the SEC and CFTC to raise the threshold to $30 billion in assets, which would still only exempt an extremely small percentage of the total swaps market from clearing requirements.

The SEC is considering a definition of bank that is similar, but not identical, to that in Section 3(a)(6) of the Exchange Act. The SEC release does not explain why it is proposing a different definition. Nor does it appear to the ABA that the Dodd-Frank Act would necessitate the changes. Absent a compelling reason to diverge from the existing Exchange Act definition, the ABA recommend that the end user exemption include the same definition to ensure consistency of interpretation in the definition of bank.

More broadly, but on the same theme, the banking group strongly urged the SEC and CFTC to adopt substantively identical provisions. Otherwise, inconsistent regulation for swaps and security-based swaps could undermine the effectiveness of exempting small banks from the clearing requirements.

A counterparty must use swaps to hedge or mitigate commercial risk in order to qualify for the Dodd-Frank end-user clearing exemption. Both the Commissions appear to agree that the definition of the term ``hedging or mitigating commercial risk?? should be the same as in their joint rule proposal defining significant terms under the regulation of swaps markets to ensure consistent interpretation as well as fair and equivalent treatment for similarly situated parties. At this time, the ABA agrees with both agencies because there is no reason for a distinct definition of hedging or mitigating commercial risk in the end-user context. The association noted, however, that the CFTC approach of incorporating a parallel definition in the end-user exemption increases the risk of inadvertent inconsistent amendment and interpretation. The ABA recommend instead using a cross reference to the primary definition.

Even if end users are exempt from the new mandatory clearing requirements, noted the ABA, they will still have to satisfy notification requirements. The Dodd-Frank Act requires each end user to notify the SEC or CFTC how it generally meets its financial obligations associated with entering into non-cleared swaps. The SEC and CFTC are authorized to establish the form for such notifications.

The ABA is concerned that the proprietary information in these notifications might be made public and cause competitive harm. The ABA urged both the Commissions to ensure that the information in the end-user notifications is not publicly disseminated, although public disclosure of whether the end user exemption was invoked would be appropriate.

Full post as published by Jim Hamilton's World of Securities Regulation on February 24, 2011 (boomark / email).