Meet the New Dodd-Frank. Same as the Old Dodd-Frank
By Colby Jenkins, TABB Group
Originally published on TABB Forum
When Congress killed the Swaps Push-Out Rule in December, it appeared as if Dodd-Frank were ready to crumble under conservative attack. In reality, not so much.
When the House narrowly passed the Consolidated and Further Continuing Appropriations Act of 2015 in early December, the media’s alarm bells started ringing. Dodd-Frank was under attack and the public needed to know. In reality, not so much.
Inserted within the $1.1 trillion must-pass government spending bill was a seemingly out-of-place Dodd-Frank amendment looking to roll back provisions aimed at migrating a small set of the “riskiest” derivatives activities outside of banks’ insured walls. This “Swaps Push-Out Rule” was the unfortunate legacy of a one-time Arkansas senator who sponsored the contentious amendment as part of a failed bid for reelection. After four years of lobbying from the Street, language had been inserted into Section 716 that significantly reduced the scope of the swaps push-out specifically to structured-finance swaps trading activity. The pressure was on the Senate two days later to make the choice: let Dodd-Frank take a hit, or face another government shutdown. Within days, the damage had been done and the Lincoln Amendment was a shadow of its original self.
The question is: What was at stake, and was it worth the fight?
The answers are pretty simple: Not much, and yes.
Looking at the original language, the scope of the push-out was pretty narrow to begin with. Interest rate swaps and currency swaps were largely, if not entirely, immune to the provision, as were cleared credit default swaps as well. This left solely equity-linked swaps, commodity swaps and uncleared credit default swaps subject to push-out mandates. Collectively, these securities make up less than $9 trillion in notional held across all U.S. banks. Small potatoes compared to the $300-plus trillion in outstanding notional for derivatives markets still remaining within the insurance walls of the banks.
From a public accountability perspective, Section 716 was never going to move the needle. Had the provisions have remained intact, there was little rationale as to how it would reduce systemic risk in the market. In fact, the push-out rule was almost unanimously opposed by regulatory heads when it was first drafted in 2010. Bernanke and Volcker both opposed the provisions from the get-go. Bernanke was even quoted opining that it would likely increase systemic risk.
The rollback certainly was a win for a small handful of banks that hold the vast majority of derivatives. For dealers that have experienced strain on their business models in the wake of the credit crisis, CDS trading remains a very profitable business, and it makes sense that they would fight to protect it. Should the push-out have gone through, the cost of pushing CDSs into non-affiliated divisions would have been tremendously costly and perhaps impossible to maintain for certain banks. This also would have led to increased complexity in the market, given that these new divisions would likely have been subject to less regulatory oversight.
Conversely, this amendment should be something of a win-win situation for both the big banks and folks with an axe to grind with Wall Street. Banks can keep nearly all their derivatives trading within their walls, yes; but the price of that will be more scrutiny than ever before.
Looking at the remaining Dodd-Frank rules to be finalized, there is a lot of land still to fight for in the New Year. Of the 90 rules related specifically to derivatives trading, nearly half missed their deadline as of December 2014 – by far the category with the most amount of work left to be done, according to Davis Polk. That leaves a lot of room for bigger problems than this to pop up, and even more room for improvement.