Sen. Richard Shelby (R-Ala.) today made the following statement on the floor of the Senate regarding his support for a Republican substitute amendment to the derivatives title of the Democrats’ financial reform bill:
Statement of Senator Richard Shelby
Wednesday, May 12, 2010
“Thank you Mr. President.
“A key part of the bill that we are considering is Title VII, which addresses the regulation of the over-the-counter (OTC) derivatives markets. While there is still debate regarding the root causes of the financial crisis, there is no debate that the lack of transparency in the OTC derivatives market was a contributing factor.
“When Lehman Brothers failed, there were press reports that banks and other large financial institutions had written credit default swaps (CDSs) on Lehman Brothers that could potentially result in $360 billion in cash pay outs.
“As it turned out, the number was less than $6 billion, but a lot of needless anxiety preceded the realization that the cash pay outs on Lehman Brothers’ CDS contracts were manageable. The regulators simply did not have the information they needed to know the magnitude of the problems they faced.
“Limited regulatory information also played a role in the demise of AIG. It is worth remembering that AIG's problems arose both in its regulated insurance subsidiaries, which were exposed to the troubled subprime mortgage market through their securities lending programs, and in its Financial Products (FP) unit, which sold credit default protection for subprime mortgage products and other customized derivatives products.
“AIG’s FP unit, on the strength of its credit rating, built up an extremely large, one-sided book of swaps transactions. The contracts were written in such a way that when AIG's credit rating was downgraded, AIG was forced to post collateral on these transactions.
“Regulators did not have the flow of information about OTC derivatives transactions to see this problem building. Without this information they obviously could not take steps to address it.
“Mr. President, I believe that the AIG bailout and the Lehman Brothers failure provided us with one simple lesson that should serve as the basic test for any OTC derivatives legislation proposal.
“The lesson is that prudential and market regulators must have the tools to properly oversee the OTC swaps markets; the lack of transparency regarding counterparty exposures and the lack of adequate regulatory tools made it difficult for regulators to respond quickly and effectively to the financial crisis.
“Unfortunately, Mr. President, the Lincoln-Dodd derivatives bill fails that most basic test.
“The Lincoln-Dodd bill does not provide regulators with access to the information they need to do their job. It requires all other regulators to go through the Commodity Futures Trading Commission (CFTC) to get information.
“It gives only begrudging access to the Securities and Exchange Commission (SEC) to data about the swaps markets and thus limits the SEC's ability to get the information that it needs to oversee the securities markets.
“Much of this bill reads more like a jurisdictional power grab than an honest attempt to ensure that all the relevant regulators have the information and the authority they need to do their jobs.
“The Lincoln-Dodd bill contains a number of other fatal flaws. For example, key provisions in one title directly contradict key provisions in other titles and current law.
“One provision in the Lincoln-Dodd bill that has gotten a lot of attention is a prohibition on federal assistance to any ‘swaps entity,’ which includes entities that do not handle any swaps.
“All clearinghouses, regardless of whether they handle swaps, would be precluded from receiving federal assistance, which is interpreted to include access to the Federal Reserve’s discount window. This provision contradicts language in Title VIII, which empowers the Federal Reserve to grant discount window access to clearinghouses.
“Also, the bill imposes a fiduciary duty on dealers when their counterparties are pension plans, endowment funds, and municipalities.
“As understood in current law, pension plans can NOT engage in transactions with entities with which they have a fiduciary relationship.
“The proposed regulatory framework also poses new risks to the system. For example, the bill anticipates generally imposing a clearing mandate on most market participants as soon as a clearinghouse will accept a swap for clearing.
“For-profit clearinghouses will have an incentive to clear as many swaps as possible.
“If they do not properly assess and collect margin for risks associated with these products or do not have sufficient operational capacity, an unanticipated event in the market could topple a clearinghouse and send devastating shock waves throughout the rest of the system.
“This bill is also anti-competitive because it further concentrates business within existing dealers. The prohibition on federal assistance, including FDIC insurance, to swap entities means that neighborhood banks will be unable to hedge their own interest rate risks, let alone offer swaps to customers who need to hedge risks.
“Bank dealers are given preferential treatment with respect to both capital and margin requirements.
“Another disadvantage for non-bank dealers is that even the commercial aspects of their business will be subject to bank-like capital requirements, which is an unprecedented expansion of bank-like regulation to non-financial corporations.
“Non-bank dealers may simply exit the derivatives business and leave the swaps business more concentrated among a few large Wall Street dealers, which is not a good result from a competitive or systemic risk standpoint.
“Mr. President, the so-called end user exemption contained in this bill is illusory.
“Main Street corporations that buy swaps in the ordinary course of business to hedge their own business risks will be subject to the same regulatory treatment as Wall Street banks. This means manufacturing firms, power companies, and even beer producers will be required to hold massive amounts of cash and other collateral simply to engage in risk management.
“This will work as an anti-stimulus plan to pull resources out of the economy, hurt growth, and slow job creation. It will also lead to price increases and price volatility.
“Mr. President, for my colleagues interested in increasing their constituents’ cooling costs in the summer or heating costs next winter; for those interested in seeing the price of orange juice, cereal, light bulbs, medicine, office supplies, building materials, cars, and computers rise; and for those who would like to make the overall cost of living for all Americans go up and the prospect of getting a job go down, the Dodd-Lincoln bill is for you.
“Finally, this bill is unworkable. The derivatives title is the one piece of this legislation that will be tested every day. The bill would make massive changes in a huge market in 180 days without the usual notice-and-comment rulemaking period that allows for broad public input.
“Neither agency has the staff that it needs to write or implement the rules. There will be enormous operational challenges for the SEC and CFTC as they gear up to monitor and receive data on all swap transactions for which there is no data repository.
“Companies all across the United States will face operational, legal, and financial challenges as they strive to come into compliance with record keeping, reporting, capital, margin, clearing, and business conduct requirements.
“Mr. President, don't just take my word for it. Take the words of a recent Bloomberg article, which was aptly titled “How 'Hard to Fathom' Derivatives Rule Emerged in the U.S. Senate.”
“Or take the words of the National Association of Manufacturers, which warned that the end-user exemption “is not strong or clear enough. In addition, other provisions in the derivatives title could effectively eliminate the exemption for many companies and, in some cases, subject them to capital and margin requirements or higher costs.”
Or, take the words of a well-respected lawyer in a memo to his clients, which contained the following criticism of the Lincoln-Dodd bill:
"Ordinarily, in writing with regard to a proposed law, the expected role of the law firm lawyer is to provide a description rather than commentary. In the case of the [Lincoln-Dodd bill], the law firm lawyer attempting a non-committal description must confront the following problems:
(1) the [Lincoln-Dodd bill's] substance is inconsistent with its stated purposes;
(2) [it] would give a degree of discretionary power to the U.S. government that is far out of the ordinary;
(3) the [Lincoln-Dodd bill] is loosely drafted in even its key provisions;
(4) it could make for radical changes in the financial system that seem not to have been considered;
(5) [the Lincoln-Dodd bill] would likely motivate institutions to move jobs to Europe, damaging the U.S. economy and particularly the Northeastern financial center economy;
(6) it would discourage banks' capital market and real estate lending in the United States by increasing their risks; and
(7) [the Lincoln-Dodd bill] would hurt banks' profitability at a time when they are struggling.”
“Or, take the words of an industry representative who urged us to change a certain provision that could prevent pension plans and government agencies from getting the services they need and another provision that could force purchasers of swaps into deals with less creditworthy counterparties.
“Or, Mr. President, take the actions of my colleagues on the other side of the aisle. While several of them have privately admitted that they fear the wrath of the Administration for speaking out publicly against the Lincoln-Dodd derivatives bill, their actions speak louder than their silence. They are apparently hard at work behind closed doors trying to make numerous, last-minute changes to this flawed bill.
“Or, Mr. President, take the words of my colleague from Connecticut himself, the Chairman of the Banking Committee.
“He was quoted earlier this week saying, “We still have work to do on [derivatives]-there's no question. We've always known that. So a lot people are spending a lot of time trying to come to some common points on this.” Mr. President, I agree with the Committee’s Chairman; the derivatives title needs a lot more work.
“Fortunately, that work has already been done. The substitute derivatives bill is Amendment #3816, "The Over-the-Counter Swaps Markets Transparency and Accountability Act of 2010." This amendment was crafted and cosponsored by several members of the Agriculture and Banking Committees.
“The substitute derivatives bill is a bipartisan product. The bill is built from the framework of the Chambliss-Lincoln bipartisan process.
“It also incorporates key concepts from the Gregg-Reed bipartisan working group that was formed by Chairman Dodd himself to hammer out real derivatives reform. The substitute derivatives bill is also a multi-committee product.
“My colleague from Georgia and I appreciate the input from the Agriculture and Banking Committees as well as important input from the Judiciary Committee on provisions that strengthen protections for customer funds in the event of a counterparty bankruptcy.
“The derivatives substitute amendment addresses five key areas of reform: introducing regulatory transparency and regulatory authority over the OTC swaps markets, mandating clearing for Wall Street dealers, minimizing threats to the financial stability of the United States, preserving Main Street’s ability to hedge their business risks, and improving public transparency.
“Mr. President, I will briefly explain each of these five areas of reform.
“First, we address regulatory transparency and regulatory authority. We must repeal the statutory provisions that prohibit regulators from overseeing the OTC swaps markets and give them access to the information they need.
“Second, we mandate clearing for Wall Street dealers. We must encourage the clearing of derivatives transactions among Wall Street dealers and dealer-like firms in well-regulated clearinghouses. This will account for a combined 80-90% of all OTC derivatives transactions.
“Third, we minimize threats to the financial stability of the United States. We must prevent the concentration of inadequately hedged risks in individual firms or central clearinghouses.
“Fourth, we preserve economically beneficial hedging for Main Street businesses.
“We must ensure that so-called corporate end users can continue to hedge their unique business risks through customized derivatives. Main Street businesses do not pose any threat to the financial stability of the United States. In fact, the prudent use of derivatives for hedging makes their businesses, the financial system, and the economy safer.
“The prudent use of derivatives enables businesses to protect themselves from changes in interest rates, swings in foreign currency exchange rates, and changing prices for raw materials. If businesses are not able to use derivatives or if the cost of using derivatives increases, they may choose to move operations overseas or curtail business operations, which will mean the loss of jobs.
“If they must refrain from hedging their risks, prices will go up for consumers.
“Fifth, we improve public transparency. Without mandating that swaps trades must occur on an exchange, we must direct regulators to provide investors and other market participants with information about recently executed transactions for the purposes of helping them to mark existing swap positions to market, make informed decisions before executing future transactions, and assess the quality of transactions they have executed.
“The Lincoln-Dodd derivatives title does not achieve these reform objectives, but, in fact, threatens to stymie real reform.
“Mr. President, the substitute derivatives amendment represents a change in course from the Lincoln-Dodd bill.
“The substitute amendment is a strong bill that offers real reform. That is why the National Association of Manufacturers ‘has indicated that all votes related to the Chambliss/Shelby Substitute Amendment (SA 3816), including procedural motions, may be considered for designation as Key Manufacturing Votes in the 111th Congress.’ It is that important to American businesses.
“Mr. President, the substitute derivatives amendment is the best way to give our financial regulators the tools they need to do their job, while also preserving the ability of our Main Street businesses to hedge business risks, add value to our economy, and create jobs.
“I urge my colleagues to have the courage to do what is right for our financial system, our economy, and ultimately the American taxpayers.”