Download the letter here.

December 2, 2014

Dear Representative,

On behalf of Americans for Financial Reform (AFR), we are writing to urge you to oppose HR 5471, legislation that would amend the Dodd-Frank Act to expand exemptions from derivatives clearing requirements for financial affiliates of commercial entities.^[1]

This legislation is both harmful and unnecessary. It is harmful because it would significantly reduce the statutory ability of the Commodity Futures Trading Commission (CFTC) to police risky behavior in the $700 trillion global derivatives markets. It is unnecessary because the CFTC has already accommodated the legitimate needs of end users through multiple no-action letters which permit affiliates of commercial entities to make use of the clearing exemption.[2]

The derivatives markets were at the center of the 2008 financial crisis, a crisis which caused trillions of dollars in damage to the U.S. economy and cost millions of Americans their jobs. The Dodd-Frank Act established a new system of oversight for these previously unregulated markets. A crucial new protection mandated in the Dodd-Frank Act was the requirement that derivatives trades be executed through central clearinghouses that would manage their risks properly and demand collateral to back up these potentially risky trades.

However, commercial companies making use of derivatives to hedge risks for manufacturing physical products or commodity raw materials were exempted from this clearing requirement, since such commercial companies make up a relatively small fraction of the derivatives market and in some cases may have limited ability to provide collateral. In addition, the Dodd-Frank Act also exempted financial entities affiliated with such commercial companies from the clearing requirement, so long as the financial entity is hedging specific production- related risk on behalf of the commercial affiliate and is acting as the agent of the commercial company in doing so.

HR 5471 would eliminate the statutory requirement that the affiliated financial entity is hedging risk on behalf of the commercial company and acting as the agent of the commercial affiliate. Should HR 5471 pass, the only statutory protection against abuse of the end user exemption by affiliated financial entities left in place would be a requirement that the financial entity was somehow hedging or mitigating the risks of a commercial affiliate. As many purely financial derivatives trades may be interpreted to somehow ‘mitigate the risks’ of the broader corporate group, including commercial affiliates, this protection is vague and provides only limited authority to the CFTC to protect against abuses of the exemption.

This seemingly technical change could have far-reaching implications. There are numerous major financial entities that have commercial affiliates and could claim that there was some relationship between their derivatives trading and hedging risks for some commercial affiliate. For example, the Senate Permanent Subcommittee on Investigations has recently documented that the major Wall Street banks engage in massive commodity production and trading activities, and stated that these “financial companies often traded in both the physical and financial markets at the same time, with respect to the same commodities, frequently using the same traders on the same trading desk.”[3] The change in HR 5471 would greatly reduce the ability of the CFTC to police risk management for this kind of co-mingling of commercial and financial activities, both at major banks and at commercial companies that have major financial subsidiaries such as GE Capital.

There are cases in which financial affiliates of commercial entities may genuinely be hedging the production-related risks of commercial affiliates but may not in a narrow sense be acting ‘as an agent’ of the commercial affiliate. Through administrative action, the CFTC has already permitted such affiliated ‘central treasury units’ to make use of the clearing exemption in a wide range of cases.[4] The agency has thus made clear that it is taking a broad interpretation of what it means to hedge ‘on behalf of the [commercial affiliate] and as an agent’, and is eager to accommodate legitimate hedging needs. But if this restriction were eliminated entirely, as HR 5471 would do, then the CFTC would be significantly limited in its ability to crack down on any attempt by financial entities to evade risk management requirements by claiming that they were mitigating the risk of commercial affiliates.

We urge you to reject HR 5471 and preserve the CFTC’s ability to properly oversee crucial derivatives markets and act when necessary to require strong risk management practices. Thank you for your consideration. For more information please contact AFR’s Policy Director, Marcus Stanley at marcus@ourfinancialsecurity.org or 202-466-3672.

Sincerely,

Americans for Financial Reform

^[1] Americans for Financial Reform is an unprecedented coalition of more than 250 national, state and local groups who have come together to reform the financial industry. Members of our coalition include consumer, civil rights, investor, retiree, community, labor, faith based and business groups.

[2] Commodity Futures Trading Commission, Division of Clearing And Risk, “No-Action Relief For Swaps Entered Into By Eligible Treasury Affiliates”, CFTC No-Action Letter 13-22, June 14, 2013; Commodity Futures Trading Commission, Division of Clearing And Risk, “Further No-Action Relief For Swaps Entered Into By Eligible Treasury Affiliates”, CFTC No-Action Letter 14-44, November 26, 2014.

[3] United States Permanent Subcommittee on Investigations, “Wall Street Bank Involvement With Physical Commodities, Majority and Minority Staff Report”, Permanent Subcommittee on Investigations, United States Senate, November 20, 2014.

[4] Commodity Futures Trading Commission, Division of Clearing And Risk, “No-Action Relief For Swaps Entered Into By Eligible Treasury Affiliates”, CFTC No-Action Letter 13-22, June 14, 2013; Commodity Futures Trading Commission, Division of Clearing And Risk, “Further No-Action Relief For Swaps Entered Into By Eligible Treasury Affiliates”, CFTC No-Action Letter 14-44, November 26, 2014.