SIFMA Testifies on Legislative Proposals Regarding Derivatives

Kenneth E. Bentsen, Jr., President & CEO of SIFMA, testified before the U.S. House of Representatives Committee on Financial Services Subcommittee on Capital Markets, Securities, and Investment at a hearing entitled “Legislative Proposals Regarding Derivatives.” His complete written testimony can be found here:  https://www.sifma.org/resources/submissions/sifma-testimony-before-hfs-subcommittee-on-capital-markets/

As the Subcommittee reviews the post-crisis regulatory regime for derivatives and considers targeted legislative improvements, SIFMA’s testimony outlined areas that could make these regulations more risk-sensitive, less complex, and clearer.

“SIFMA believes that many key pillars of the regime implemented by Title VII of the Dodd Frank Act– enhanced transparency requirements, central clearing for standardized swaps, and capital and margin requirements designed to address the risks of non-cleared swaps – should remain in place,” Kenneth E. Bentsen, Jr., President & CEO of SIFMA, noted in the testimony. “SIFMA is concerned, however, that some of the regulations adopted as part of these reforms go beyond what is necessary to achieve core risk mitigation and transparency objectives and may even be in conflict with or redundant to other regulations on the books. SIFMA and its members are pleased to see that policymakers are now evaluating these issues as they take stock of recent derivatives reforms.”

SIFMA’s testimony focused on four key areas of reform as Committee members consider legislative proposals:

Treatment of Transactions Between Affiliates

SIFMA supports legislative measures to fix the current application of Title VII requirements to inter-affiliate transactions. We believe that an appropriate and targeted solution would be to exempt inter-affiliate swaps from initial margin, mandatory clearing, and mandatory trading requirements, so long as they are part of a centralized risk management program and remain subject to variation margin and trade reporting requirements.

This approach would bring the banking regulators’ margin rules in line with the CFTC’s and help streamline existing CFTC exemptions.

Agency Review and Harmonization of Rules Relating to the Regulation of Over-the-Counter Swaps Markets

The regulatory distinction between “swaps” and “security-based swaps” as defined by Title VII did not accurately reflect market practice, and the resulting jurisdictional split between the CFTC and SEC has posed challenges for market participants.  Despite some efforts by the agencies to coordinate and harmonize their Title VII requirements, important differences in these requirements remain.  SIFMA has long encouraged the CFTC and SEC to identify additional opportunities to simplify, harmonize and streamline their respective Title VII requirements, where appropriate.  In particular, the SEC and CFTC should look for more opportunities to leverage each other’s rules, especially for dual registrants.  SIFMA also supports coordination between the markets regulators and the U.S. banking regulators, especially in relation to capital and margin requirements.

It is important for regulators to recognize instances where satisfying another domestic or foreign regulator’s requirements would achieve a comparable regulatory outcome while avoiding the complexity and uncertainty associated with overlapping regulations.  It is thus essential for regulators to harmonize requirements wherever possible, to avoid situations where market participants are faced with duplicative, inconsistent or conflicting requirements.

Regulatory Capital Requirements

Regulatory capital requirements should be based on the principle that taking greater risk requires greater capital. Completely risk-insensitive leverage capital measures, such as the supplemental leverage ratio (SLR), are becoming the binding capital measures for many banking organizations, and the standardized risk-based capital requirements do not permit sufficient use of more risk sensitive methodologies.

Because the SLR’s approach to client clearing requires clearing firms to hold capital against these exposures far in excess of the risks they face, it discourages client clearing activity. SIFMA accordingly supports H.R. 4659, as it would deduct any client-provided initial margin on centrally  cleared derivatives from the amount of leverage exposure for the firm clearing the swap, and requires the banking regulators to amend their leverage-based capital rules to reflect this change.

Establishment of De Minimis Exception Annual Thresholds for Swap Dealers and Security-Based Swap Dealers

SIFMA believes that any determination to modify the de minimis threshold exempting a market participant from being deemed a swap dealer or security-based swap dealer must be supported by reliable, complete and robust data to avoid uncertainty and disruption in the swap markets.

In addition to setting their de minimis thresholds at an appropriate level, it is also critical for the CFTC and SEC to tailor what types of transactions count toward those thresholds. In particular, we are concerned about the extent to which the agencies currently require firms to count non-U.S. transactions, even transactions entered into by affiliates subject to comparable foreign regulation. We believe it is imperative that the agencies appropriately tailor the scope of transactions that lead to swap dealer or security-based swap dealer registration in the cross-border context.