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April 18, 2012

Swap Dealer Rule Is An "Indefensible Retreat" From Financial Reform

Dennis Kelleher, president and CEO of Better Markets, made the following statement on the rule adopted today by the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). The rule would define the firms to be classified as swap dealers and major swap participants:

This rule is an indefensible retreat from financial reform.  It is also a poster child for the pernicious effect of industry’s army of lobbyists and the influence that the financial industry has at the regulatory agencies.  The agencies’ duties are to enforce the law and protect our financial system and the economy from the reckless and risky activities of an industry that has proved time and again that it simply cannot control itself.  This does the opposite:  it protects the industry while putting other market participants and the markets themselves at risk.

Transparency and oversight are essential to taming the unregulated “anything goes” mentality and operations of the dark $700 trillion derivatives markets, which were at the core of the last financial crisis.  Rather than shining a light on those activities, these agencies are giving the green light for market players to continue with business as usual.  Dark, unregulated markets are in no one’s interest, other than predators. 

Some are justifying this rule by claiming that it will regulate the biggest dealers and banks as if those are the only entities that the law is concerned with.  That simply is not consistent with the express terms of the law. Systemic riskiness posed by the biggest entities is just one of three criteria which the statute directs the CFTC to use when selecting “major” swap participants. The others include any participant with high leverage, or a “substantial” position in swaps, whether collateralized or not. This, of course, includes the biggest dealers and banks, but the law is not limited only to them and the rules should not be thus limited either.

Specifically, here’s how this rule keeps these dangerous, risk-filled markets a threat:

*It allows all but the largest derivatives dealers, including banks with billions of dollars in revenues, a potentially limitless exemption from oversight by excluding any swaps they claim are hedging some risk associated with their business. Given that the rule allows every swap dealer to decide for itself what is or is not a hedge or a “business” risk, there can be no doubt that abuse and evasion of this provision could be rampant. 

*Major traders in the marketplace would escape greater scrutiny even if they are highly leveraged (up to 12 to 1 leverage) or hold massive books of risky trades so long as those risks are partly offset with collateral. These bets, however, could still be large enough to bring down the entire financial system.

*It would also create a major loophole by raising the de minimis threshold for dealer registration and oversight from $100 million to $8 billion.  By no definition is $8 billion de minimis.  It is a “de maximum” loophole that cannot be justified.  It would exempt as much as 60 percent of the swap dealers from reporting, registration and collateralizing requirements. 

*While the rule leaves open the possibility that the $8 billion de minimis threshold could drop to $3 billion within five years, there are virtually unlimited opportunities for industry to keep it at the higher level through its lobbying efforts.  Their success in this rule do not bode well that the agencies will get tougher in the future. 

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