When you spoke to Business Roundtable’s meeting on December 5, 2012, you offered to work to improve the effectiveness of federal regulations if we identified specific regulations of concern for review by your Administration. One serious example I want to bring to your attention concerns the implementation of the derivatives title of the Dodd-Frank Act.
Later this year, federal regulators are expected to apply certain derivatives regulations equally to end-user companies and bank swap dealers. Our concern is that derivatives trades entered into by end-users, as Federal Reserve Board Chairman Bernanke has publicly noted, do not contribute to systemic risk. Over-regulating trades by end-users would succeed only in reducing such trades, which means that end-users would manage their risk less effectively without any measurable benefit to the economy as a whole.
By way of example, Eaton uses derivatives to mitigate risk in its daily businesses. It employs them in order to hedge its exposure to fluctuations in interest rates, commodity prices, and currency valuations. Because Eaton is a multi-national company, it also trades within its own affiliate structure to balance exposure across country borders and to more efficiently enter into trades with external counterparties. These internal transactions should not be dealt with in the same regulatory manner as derivatives utilized by major financial trading houses. In this respect, Eaton is very representative of Business Roundtable’s membership – namely, end-users that deserve a full exemption for their derivatives use.
The key financial reforms in Dodd-Frank were designed to promote economic stability and transparency without imposing undue burdens on end-users. The reason is evident as imposing unnecessary costs and burdens on end-user companies, whose derivatives trading was not a cause of the financial crisis, would restrict job growth, decrease productive investment, and hamper U.S. competitiveness in the global economy.
There are two related rules that pose particular problems to the corporate community. The first, proposed by the prudential banking regulators, would impose margin requirements on end-user trades. According to one survey, even a 3% initial margin requirement could reduce capital spending by $5-7 billion among S&P 500 companies alone and cost 100,000 - 120,000 jobs. End-users should continue to have the ability to manage risk without the threat of unnecessary and costly margin requirements. When Congress approved the final version of this measure, it did not intend for end-users to have to comply with margin requirements.
The second problematic rule would impose unnecessary requirements on certain internal, “inter-affiliate” swaps and penalize end-users for using central hedging centers to manage their commercial risk. The proposed rule poses two serious problems.
First, financial end-users would have to clear purely internal trades between affiliates unless end-users post variation margin between the affiliates or meet specific requirements for an exception. Financial end-users, including pension plans, captive finance affiliates, mutual life insurance companies, and commercial companies with non-captive finance arms, use derivatives the same way non-financial end-users do. If these end-users are required to post variation margin, there is little point to exempting inter-affiliate trades from clearing requirements, as the costs would be similar. These trades do not create systemic risk and, hence, should not be subject to bank-like regulation.
Second, many end-users execute swaps through an affiliate, as many companies find it more efficient to manage their risk centrally and to have one affiliate trading in the open market instead of dozens or hundreds of affiliates making trades in uncoordinated fashion. This structure allows expertise to be centralized and also allows companies to reduce the amount of outward-facing trades and realize better pricing. If regulators apply the Dodd-Frank Act to non-financial end-users, these companies will face a costly choice: either dismantle their centralized treasury units or find new ways to manage risk or clear all of their internal trades. Stated another way, this problem threatens to deny the end-user clearing exception to many end-users because they have chosen to hedge their risk in an efficient, highly-effective, and risk-reducing way. It is difficult to believe that this is the policy result Congress hoped to achieve with the enactment of Dodd-Frank.
Instead, regulation of inter-affiliate trades should square with a simple economic reality: internal trades do not increase systemic risk. Thus, imposing requirements that are designed to address systemic risk on inter-affiliate trades would create costs and tie up capital that could otherwise be directed toward investment and innovation without a corresponding benefit, placing substantial burdens on end-users and consumers alike.
These are complicated rules, but they lead to a very simple result: dissuading companies from engaging in responsible and highly effective methods of managing their risk.
Our members have been working with the derivatives regulatory agencies to address these problems and the regulators – particularly the CFTC – have been very open to listening to our concerns. That said, thousands of end-user companies now face looming regulatory deadlines and your assistance could make the difference between the imposition of costly and unnecessary regulations and a more rational approach to managing derivatives markets.
Thus, we ask that you work with us to fix these proposed rules before they do serious damage to our economy. Thank you very much for considering this request. We would appreciate the appropriate member of your staff contacting Don Green, of Business Roundtable at (202) 496-3275 or dgreen@brt.org to discuss this topic in more detail.
Sincerely,
Alexander M. Cutler
Chairman and Chief Executive Officer
Eaton
Chair, Corporate Governance Committee
Business Roundtable
SC/dg
C: Denis McDonough, Chief of Staff, The White House Valerie Jarrett, Senior Advisor to the President, The White House Gene B. Sperling, Assistant to the President for Economic Policy, The White House