May 19, 2024

DealBook: Regulators Approve New Rules for Derivatives

Under the plan, wide swaths of non-financial companies, like Ford, are excused from certain provisions under Dodd-Frank.John Sommers II/ReutersUnder the plan, wide swaths of non-financial companies, like Ford, are excused from certain provisions under Dodd-Frank.

3:57 p.m. | Updated

Regulators on Tuesday took a major step toward reining in risky Wall Street trading, approving new rules aimed at preventing a repeat of the financial crisis.

The rules, stemming from the Dodd-Frank financial regulatory law, will give regulators more control over the $700 trillion derivatives industry, an opaque business at the center of the crisis. While regulators have spent more than two years retooling the sector, the latest package of reforms laid crucial building blocks for the remaining aspects of the Wall Street overhaul.

“Light will begin to shine on the markets for the first time,” Gary Gensler, chairman of the Commodity Futures Trading Commission, which approved the rules, said at a public meeting. “This is a very significant day for the American public.”

But another member of the agency questioned whether last-minute changes undermined the rule, allowing risk to seep back into the system. Bart Chilton, a Democratic commissioner who cast the lone vote against the plan, raised concerns that the fine print created loopholes wide enough for Wall Street to exploit.

“There are lots of lawyers out there itching to find ways for their clients to get around Dodd-Frank,” said Mr. Chilton, an outspoken advocate of regulation who never before voted against a final Dodd-Frank rule.

Capping months of frenetic corporate lobbying, the agency on Tuesday also approved a set of policies spelling out a key exemption from regulation. Under the plan, wide swaths of non-financial companies and small banks are excused from certain provisions under Dodd-Frank. The carve-out, regulators say, would exclude from some oversight about 30,000 manufacturers, gas companies and airlines, including companies like Ford and Exelon.

The vote came nearly two years after Congress enacted Dodd-Frank, which for the first time mandated an overhaul of swaps trading, the derivative contracts tied to the value of commodities, interest rates and mortgage securities. One form of derivatives, credit-default swaps, nearly toppled the giant insurer American International Group and deepened the financial crisis.

Under Dodd-Frank, big banks and other financial institutions must submit certain derivatives contracts to regulated clearinghouses, which serve as a backstop in case one party in the trade defaults.

But Wall Street was in a holding pattern until regulators took action on Tuesday. The new plan, which defined key derivatives terms like “swap,” will now trigger a cascade of other Dodd-Frank measures. The definitions underpin the law, ushering in a requirement that big banks like JPMorgan Chase register with regulators. The definitions also lay the groundwork for a battery of reporting requirements, risk management procedures and ultimately capital standards. Some requirements will kick in about two months from now.

“There’s no question this is an incredibly foundational rule for the industry,” said Gabriel D. Rosenberg, an attorney at Davis Polk, which represents some of the biggest names on Wall Street. “The clock has started ticking and it’s a clock with a very short fuse.”

The agency said its definitions would cover most known swaps contracts while excluding insurance products, so-called forward deals and consumer transactions, like contracts to buy home heating oil. The Securities and Exchange Commission unanimously approved a similar version of the rule last week.

“By finalizing these rules, we are completing the foundation of a new regulatory regime intended to reduce systemic risk and bring greater transparency to this multi-trillion dollar market,” Mary L. Schapiro, the S.E.C.’s chairwoman, said in a statement.

But Mr. Chilton questioned whether the exclusions were overly broad, going beyond what the S.E.C. agreed to last week. Indeed, the Commodity Futures Trading Commission delayed its Tuesday meeting nearly an hour to hammer out a last-minute compromise over the minutiae of the rule.

“One man’s loophole is another man’s livelihood,” Mr. Chilton said.

Separately on Tuesday, the Commodity Futures Trading Commission unanimously approved a broad exemption from the requirement that derivatives trades go through regulated clearinghouses. The rule, the subject of more than a year of fierce lobbying from some of the nation’s biggest corporations, was meant to shield companies from the burdens of Dodd-Frank.

It applies to “commercial end users” – an array of oil companies, airlines and other firms that use swaps to counteract risk associated with a potential swing in value of goods that they purchase or manufacture. An airline, for instance, uses swaps to hedge against the fluctuating cost of jet fuel. Commercial companies also buy swaps to protect against jumps in interest rates.

Under the agency’s final rule, swaps need not go through clearinghouses if at least one party in the trade is a “non-financial” entity and is using the swap to hedge against “commercial risk.” The exempt firms, which are expected to number 30,000, must still alert regulators when they enter into swap transactions.

Regulators also extended the exemption to small banks and other financial firms outside the glare of Wall Street. The final rule allowed the firms with total assets of $10 billion or less to qualify for the end-user exception.

With the rules receiving approval, the agency further whittled down its lengthy list of Dodd-Frank responsibilities. The agency, Mr. Gensler said, has blessed some 35 final rules with about 15 remaining.

“Just by the math you can see we’re quite a way into this,” Mr. Gensler said.

“But I think it is critical we finish the job, protect the market and promote more transparent and healthier markets.”

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