Doing “a Big Number” on Commodity Market Regulation
By Steve Suppan, Institute for Agriculture and Trade Policy
Then-candidate Donald Trump campaigned as the scourge of Wall Street. But now-President Trump has promised to “do a big number” on the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act. Most media coverage of the promised “big number” has focused on the gutting of the Consumer Financial Protection Bureau and the pushing through of legislation that U.S. House of Representatives Minority Leader Nancy Pelosi called “this disastrous Wall Street First bill.”
At the Commodity Futures Trading Commission (CFTC), the “big number” has taken the form of a notice for a proposed rule to introduce a “big number” of exemptions and exclusions to calculating the “de minimis” quantity of trading activity that would trigger Dodd-Frank authorized registration, regulation and reporting requirements for dealers of a commodity derivatives instrument called a “swap.” The Wall Street insolvency crisis and taxpayer bailouts of 2007-2010 were in part caused by the failure to regulate swaps trading and the undercapitalization of Goldman Sachs, J.P. Morgan, Morgan Stanley, Citigroup and other major swaps dealers to cover their losses.
In its comment on the notice, IATP agreed with and cited passages from Commissioner Rostin Benham’s wide-ranging dissentto the rule’s release for comment. Commissioner Benham wrote that “ancillary considerations” outlined in the notice of rulemaking “may signify the Commission’s willingness to exploit the de minimis exception to undermine the swap dealer definition and circumvent Congressional intent” of the Dodd-Frank Act.
Among these “ancillary considerations” is a provision that would allow each of an estimated 108 swaps dealers to propose their own methodologies for calculating the annual gross notional amount (ANGA) “for any group, category, type or class of swaps.” The ANGA multiplies the spot price of a swap by the contract units of the swap transacted. According to the Bank for International Settlements, the coordinating body of all central banks, the global ANGA for all classes of swaps at the end of 2017 was U.S. $532 trillion. However, the same report continues, “In contrast, the gross market value of OTC derivatives [i.e. swaps], which provides a more meaningful measure of market and counterparty credit risk, continued to decline, from $13 trillion at end-June 2017 to $11 trillion at end-2017.” This departure from the ANGA reflects the difference between the gross value of the swaps and the later swap market value reconciled by offsetting (betting for and against price moves) by all counterparties to all swaps contracts.
As this huge difference between the ANGA (the traditional swaps dealing activity metric) and the gross market value (a recent BIS metric) indicates, there is an international bank regulator debate about how to measure swaps dealing activity. Commissioner Benham wrote in his dissent, however, that the introduction of that debate so late in the CFTC rulemaking process was another reason for his vote against the proposed rule’s release for comment.
Under the proposed rule, swaps dealers would calculate which swaps would count towards the quantitative ANGA threshold that triggers dealer registration and regulation. IATP called this proposal an “exclusion multiplier” that would eviscerate the regulation of swaps dealing and undermine the policy objectives of both Dodd-Frank and the Commodity Exchange Act.
The swaps dealer calculation methodologies would have to be approved by the CFTC Director of the Division of Swap Dealer and Intermediary Oversight (DSIO) as being “economically reasonable” and “analytically supported.” IATP maintains, though, that allowing the swaps dealers to calculate their own de minimis would radically reduce the number of swaps dealers subject to CFTC regulation. The understaffed and under-budgeted CFTC staff will default to approving each dealer’s de minimis calculation methodologies and trust that the approved policies are rigorously applied. Given the sharply increased federal budget deficit that is likely to result from the $1.5 trillion in tax cuts enacted by President Trump and the Republican majority, the resources needed to regulate swaps dealers will not be forthcoming. Although the rule contains a standard provision against regulatory evasion, the burden of proof remains with the CFTC to show that swaps dealers used the calculation methodology to deliberately avoid dealer registration and regulation. Demonstrating intent to evade regulation is both a costly and steep burden of proof.
The data integrity of agriculture, energy, and base and precious metal swaps trading is so poor that the CFTC does not include these non-financial commodities in its weekly swaps trading report. In fact, one analyst recently characterized commodity swaps data as a swamp. As a result, agricultural commodity traders manage price risks almost entirely in the regulated and relatively transparent futures and options markets. However, as IATP pointed out in its comment, the “greater impact of SD [swaps dealer] self-regulation will be in the foreign exchange and interest rate swaps that will affect respectively, agricultural export sales and a broad array of individual farm household investments, including servicing debt for farm machinery, residential home and out building mortgages, credit card debt and student loan debt.” In other words, the deregulation of the swaps market will affect not just the pricing of agricultural commodities, but the cost of farm operations and financial instruments used by farm household members.
According to Commissioner Benham’s dissent, the proposed notice of de minimis rulemaking arrived in his office just 17 hours before the final draft had to be sent to the CFTC Office of the Secretariat to print the voted-on text. Given all the exclusions from the swaps de minimis threshold in the proposed rule, Commissioner Benham’s dissent called for a full public discussion of proposed changes to swaps de minimis calculation and swaps dealer regulation. IATP agreed and added that the Commission vote to finalize the rule should be with the full five-member Commission and not with its current three members. CFTC Chairman Christopher Giancarlo, in testimony to the House of Representatives Agriculture Committee and in speeches to industry groups, has committed to finalizing the rule in 2018.
Very often, the legal authority for provisions in this proposed rule is not Dodd-Frank nor the Commodity Exchange Act, but rather industry responses to a CFTC Request for Information on Project KISS (Keep It Simple Stupid). Chairman Giancarlo told the Futures Industry Association, “Project KISS is not about changing policy. It’s designed to simplify and make our rules and regulations less complex, less costly, less burdensome.” Nevertheless, the International Swaps and Derivatives Association and other industry groups responded to the Request for Information with dozens of policy change proposals. The dozens of exclusions and exemptions proposed for the de minimis swaps rule would save swaps dealers the costs of complying with CFTC rules. However, those exclusions and exceptions would not comply with the public interest objectives of Dodd-Frank and the Commodity Exchange Act.
The legal authorities for Project KISS are President Trump’s executive orders that demand elimination of regulations to fulfill budgetary objectives, rather than eliminating regulations through the Administrative Procedures Act (APA), which governs all federal rulemaking and regulatory actions. IATP advised the CFTC that it must not finalize any rule to be consistent with Project KISS, since the APA legality and, indeed, the constitutionality of President Trump’s executive orders are the subject of a lawsuit currently before the U.S. District Court for the District of Columbia. Even if the Trump administration were to prevail against the plaintiffs (Public Citizen, the Natural Resources Defense Council and the Communication Workers of America) in District Court, the preemption of congressional statutes that authorize regulations by a presidential executive order would likely result in an appeal all the way to the U.S. Supreme Court.
The members of the International Swaps and Derivatives Association and the Futures Industry Association will welcome a rule that weakens CFTC regulation of swaps dealers. But anyone who prioritizes compliance with the Dodd-Frank Act and the public interest objectives of the Commodity Exchange Act should oppose the evisceration of swaps dealer regulation by the “big number” of exclusions and exemptions in the proposed de minimis swaps rule. Regulating financial instruments to comply with those objectives—including protecting market participants and market integrity and enabling fair and transparent price discovery in financial and commodity derivatives markets— is crucial to the financial well-being of both farm households and farm operations.