Exchanges and industry voice concerns over finance reform bill

by L. Joshua Sosland
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WASHINGTON — As finance reform legislation was pushed to the top of the agenda in the Senate, prominent agriculture industry associations and futures exchanges voiced concerns over certain provisions of the bill that might disadvantage entities not complicit in the near breakdown of the financial system even as they faced an increasingly competitive environment.

Most concerns centered on sections of the Wall Street Transparency and Accountability Act of 2010, which was passed by the Senate Committee on Agriculture, Nutrition and Forestry by a 13 to 8 vote on April 21 and subsequently incorporated into the finance reform bill currently before the Senate, The Restoring American Financial Stability Act, S. 3217.

The agriculture committee’s bill dealt with the regulation of derivatives. It would grant the Securities and Exchange Commission regulatory jurisdiction over securities-based swaps and the Commodity Futures Trading Commission jurisdiction over all other swaps, unless otherwise stipulated in legislation. The bill would continue to limit participation and trading in agricultural swaps, unless exempted by the C.F.T.C., which reflects the current policy.

The bill would require swaps to be cleared on an exchange or another derivatives-based clearing organization with the C.F.T.C. authorized to determine which swaps are to be cleared. There would be exemptions from the clearing requirements for nonfinancial institutions, e.g. end users such as manufacturers, agriculture companies and commodity producers.

The S.E.C. and the C.F.T.C. would be authorized to report on any swap or securities-based swap found to be detrimental to the stability of financial markets. In the event of a future financial crisis, federal assistance to swaps entities in connection with their trading in swaps or securities-based swaps would be prohibited. The bill would impose registration and reporting requirements on swap dealers and require public reporting of aggregate swap data.

Section 125 of the agriculture committee’s bill would grant the C.F.T.C. rulemaking authority over futures margins and impose specific criteria for margin-setting, but the bill would not authorize the C.F.T.C. to set margins for specific contracts.

The C.F.T.C. would be authorized to impose speculative position limits on swaps that perform or affect a significant price-discovery function.

Section 134 of the agriculture committee’s bill would provide a new process for prior approval of rules and rule amendments sought by exchanges and clearing organizations. These entities would have to provide a seven-business-day precertification notice to the C.F.T.C. regarding new rules and rule amendments, including all relevant information. Once a new rule or rule amendment is officially certified, the C.F.T.C. would have 10 business days to review the rule or rule amendment for compliance with the Commodities Exchange Act. The agency would be required to approve the rule or amendment unless it violated the C.E.A., and the C.F.T.C. would have to approve any new contract unless it violated the C.E.A.

Section 134 also would repeal the procedures required of the C.F.T.C. before it may bring an enforcement action against a registered entity for violation of a core principle of the C.E.A., so such actions may be brought on the same basis as any other C.F.T.C. enforcement action.

Officials of the Kansas City Board of Trade expressed concerns especially with regard to Sections 125 and 134 of the agriculture committee’s bill now incorporated into the overall financial reform bill.

First, there was the concern that should the C.F.T.C. be given authority over contract margins and margin-setting criteria, the agency, while not setting margins itself, would influence the level of all exchange contract margins.

“We feel that exchanges should have exclusive authority over futures margins,” said Jeff Borchardt, president of the Kansas City Board of Trade. “Our capital and reputation are at risk, and we feel that we are in the best position to determine our level of risk tolerance given the overall market environment.

“A perfect example of this was late 2007 to early 2008, when grain prices soared to record levels. We made the business decision, given the margin credit financing stress placed on commercial grain companies and banks, to set our margin levels based on the current daily price limit.  When wheat was trading under a 60c limit, our margins were 60c.  When limits expanded to 90c, we increased margins to 90c. As soon as limits contracted back to 60c, we lowered margins to 60c. This practice allowed us to cover our daily risk without collecting excess margin, which would have only exacerbated the margin credit financing problems.”

Mr. Borchardt was critical of the bill’s casting aside of certain benefits derived from the Commodity Futures Modernization Act of 2000 including provisions that enabled exchanges and clearing organizations to certify rules and rule changes on two days’ notice instead of the 17-day process as proposed in the bill.

Mr. Borchardt said there was no occasion during the last 10 years when a rule certification was found to be invalid by the C.F.T.C. and he saw no need to change the current process that he said helps domestic exchanges respond quickly to competitive threats from over-the-counter and foreign markets.

The bill’s provision in Section 134 eliminating current procedures for the C.F.T.C. to bring an enforcement action against exchanges or other registered entities for violating a “core principle” was counterproductive with regard to fostering a cooperative regulatory environment, Mr. Borchardt said. Currently, the C.F.T.C. is required to notify an exchange of an alleged violation of a core principle, and a 30-day “cure period” enables the exchange to achieve compliance.

The exchanges and agriculture industry organizations were successful in persuading the agriculture committee to modify the bill’s language directed at “insider trading” before it was voted on. Both the National Grain and Feed Association and the Commodity Markets Council lobbied the committee saying they supported the intent of the original measure, which was to ensure U.S. government employees not trade on non-public, government information obtained by virtue of their positions, or communicate such information to others. But the original language used in the measure to accomplish this end was too expansive and might have “chilled” necessary communications between private entities and agencies of the government such as the U.S. Department of Agriculture, the Department of Energy and the C.F.T.C., the associations asserted.

The insider trading provision ultimately approved by the committee accommodated the primary concerns of industry.

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