Manufacturers use derivatives to hedge against fluctuations in interest rates, currency, and commodity prices. These derivatives end-users did not contribute to the financial crisis, but could soon face regulatory requirements intended for the financial institutions that were responsible. That is, unless Congress steps in to pass legislation to protect manufacturers and other end-users. (continue reading…)
Manufacturers are one step closer to gaining certainty on whether they will be faced with unnecessary regulatory hurdles simply for structuring in an efficient way to manage business risk.
Many manufacturers use derivatives to hedge everyday business risks stemming from fluctuations in commodity prices, currency and interest rates. These manufacturers, and other nonfinancial end-users, typically employ a “command center” called a centralized treasury unit (CTU) to oversee the company’s derivatives transactions, vital to a manufacturer that has multiple affiliates. (continue reading…)
Yesterday morning, the Federal Reserve Board released a re-proposed rulemaking regarding “Margin Requirements for Non-cleared Swaps.” At first glance, this long awaited re-proposal seems to acknowledge what end-users like manufacturers have long held, that when derivatives are used by non-financial end-users to hedge commercial risk, manufacturers should not face the same margin or capital requirements as financial entities engaging in swaps for other purposes. However, it appears as though the Fed in the new proposal has chosen to allow the decision as to whether margin is required to remain between the manufacturer and their financial counterparty, rather than be imposed by a third-party regulator.
As a leader of the Coalition for Derivatives End-Users, the NAM has worked over the past several years to share manufacturers concerns about the potential costly burden that such margin requirements. So we are pleased that at least at first blush the Fed appears to acknowledge manufacturers’ concerns. As we dig through the full 200 page re-proposed rule we are hopeful that this rule, if finalized, could provide manufacturers the reassurance that they will not face this significant cost burden. The NAM and the Coalition will be working in the coming weeks to determine if the re-proposal addresses all of the concerns of manufacturers who use derivatives to hedge commercial risk and if additional changes to the re-proposed rule are necessary.
Earlier this week the NAM, on behalf of the Coalition for Derivatives End-Users where we serve as a steering committee member, sent a letter to every Senate office signed by over 50 companies – large and small – urging swift action on the passage of legislation to follow-through on the stated intention of the authors of the Dodd-Frank Act to exempt non-financial end-users from mandatory margin requirements imposed by regulators. Three years after the enactment of this law, companies are still left wondering whether they will need to sideline billions of dollars into margin accounts. Company after company has indicated that the cost of margin requirements which could be imposed by the Prudential (banking) regulators could sideline hundreds of millions of dollars to margin trades that simply seek to reduce commercial risk. As we’ve said in this space time and again, non-financial end-users, like manufacturers, do not use derivatives to speculate but simply to manage their own costs and risks inherent in doing their day to day business. End-users did not cause the financial crisis and throughout the Dodd-Frank debate the bill managers made clear that they intended to exclude end-users from new regulations that sought to reduce the speculative trading that contributed to the crisis, thus the clear inclusion of the end-user clearing exemption included in Title VII.
Unfortunately, despite various floor discussions that sought to build the legislative history to support the end-user exemption from margin requirements, today end-users face varying views of the statute from various regulators. This has been at the crux of the issue over the past two year. The Fed believes they have a statutory requirement under the Act to impose some level of margin requirement on all swaps, the CFTC on the other hand believes that they have the authority to exempt end-users… thus the uncertainty and the concern amongst businesses that they may need to make decisions later this year that would allow them to free up hundreds of millions of dollars to sit in margin accounts.
This issue, which has been of great concern to the NAM and the broader Coalition, is now coming to a head with regulators indicating that they plan to finalize margin rules later this year. Now is the time for the Senate to act and pass legislation (H.R. 634/S.888) to provide the clarification necessary to end the uncertainty. The bill was passed last month for the second year in a row by an overwhelming bipartisan majority of the House of Representatives who supported the bill by a vote of 411-12. The NAM is pleased that this issue is one that will be explored later this afternoon in a Senate Agriculture Committee Hearing on the reauthorization of the CFTC and the Commodities Exchange Act. Earlier this spring, the NAM submitted a letter requesting that the Committee take up this issue during the reauthorization process and we are pleased that this issue it is being addressed in today’s hearing by Jim Colby, an assistant treasurer at NAM Member Honeywell International. Jim’s testimony speaks to the need for swift action on this issue and explains the impact on a diversified technology and manufacturing leader like Honeywell.
Manufacturers, and the broader economy, do not want to feel the impact of the sidelining of billions of dollars to meet requirements that were never intended for this sector.
As the old saying goes, every journey begins with a first step. We had a few positive and solid first – and second – steps today for derivatives end-users.
A little while ago, the House Financial Services Committee completed a markup on a number of Dodd-Frank related bills including H.R. 634, “The Business Risk Mitigation and Price Stabilization Act of 2013” and H.R. 677, “Inter-Affiliate Swap Clarification Act”. H.R. 634 was reported out of committee with a unanimous 59-0 vote and the inter-affiliates bill was reported favorably with a vote 50-10. We believe that now that the relevant committees have both completed their review of these common-sense and critical bills, the House leadership will bring them to the floor for consideration by the full House of Representatives in the coming weeks.
Also this afternoon, Sens. Johanns and Tester led a large bipartisan group in introducing the Senate companion to H.R. 634 (the number is not yet available). The full list of original cosponsors includes: Senators Mike Johanns (R-NE), Jon Tester (D-MT), Roy Blunt (R-MO), Mike Crapo (R-ID), Joe Donnelly (D-IN), Kay Hagan (D-NC), Heidi Heitkamp (D-ND), Amy Klobuchar (D-MN), Jerry Moran (R-KS), Richard Shelby (R-AL), Pat Toomey (R-PA) and Mark Warner (D-VA).
The Senate introduction came on the heels of a concerted effort by end-users to educate Senate offices on the realities of end-user use of derivatives trades – we use them to hedge every-day commercial risk, not for speculative purposes. Thus, end-users like the thousands of manufactures who utilize these risk-management tools shouldn’t be regulated the same was as those companies that are speculating.
We continue to work with Senate offices to get a Senate companion to H.R. 677 (the inter-affiliates bill) introduced in the near-term. So although this is certainly positive progress, we are simply nearing the beginning of the second-act which is getting the Senate to take action on both of these important and common-sense bills that will ensure that main street businesses are able to focus on growing and investing in their business and their growth.
End-users continue to watch the time tick by on the countdown clock to the implementation of various aspects of Dodd-Frank while still awaiting clarity on a couple of critical – and costly – regulatory burdens which currently seem poised to impact them. In an ongoing effort to help find that clarity, the NAM has been working diligently as a leading member of the Coalition for Derivatives End-Users on both the hill and before the regulatory bodies implementing the law. Today we hope marked a positive step forward in the House Agriculture Committee’s hearing, “Examining Legislative Improvements to Title VII of the Dodd-Frank Act,” which featured testimony by NAM member and Honeywell International Assistant Treasurer Jim Colby. Colby testified on behalf of Honeywell and the Coalition — in support of coalition-backed legislation H.R. 634, which would provide a clear exemption from margin requirements for non-financial end-users as was the original intent of Congress.
The NAM has long advocated for this legislative fix and has worked longside the Coalition at the regulatory bodies urging that the rules promulgated under Dodd-Frank include this exemption. During the last Congress, the same legislation cleared the House overwhelmingly with over 370 votes in favor and withered in the Senate despite bipartisan support. We’re hopeful that today’s hearing and Ag Chairman Lucas’ indication that the Committee will soon move to mark up the bills included in the hearing will result in quick action that will allow the bill to be considered by the House Financial Services Committee and by the full House of Representatives in the near term.
The hearing also featured testimony in support of another NAM and Coalition endorsed bill, H.R. 677 which would exempt inter-affiliate and centralized hedging center unit swaps from clearing and other regulatory requirements intended for market-facing swaps. This legislation also clarifies a provision in Dodd-Frank that failed to distinguish internal risk management techniques in the form of inter-affiliate swaps from external market facing swaps. Many companies today use centralized hedging centers or centralized treasury units as a risk management tool – one that is often considered a best-practice. Under Dodd-Frank it this structure wasn’t contemplated and today without a change, the internal swaps a company does between these centers and their own affiliates would be subject to the same costly reporting and clearing requirements as external swaps with a swap dealers or a major swap participant. Further, the bill ensures that non-financial end-users who utilize these centralized hedging centers are allowed to use the end-user clearing exemption. Without this clarification, these centralized hedging and treasury centers wouldn’t qualify for the end-user clearing exemption because they would be deemed financial entities since their primary function is to engage in financial transactions for the corporate parent.
We are pleased that the committee also considered H.R. 677 today and hope that it too will be marked up and ready for review by the House Financial Services Committee and the full House in the near-term. A predecessor of this bill moved in tandem with a margin bill last year and also passed the House with over 350 votes. We hope to see that replicated soon.
So, while the clock ticks, hopefully today’s hearing is the first steps towards fixing these two burdensome problems casting a shadow over sound risk management practices employed by end-users.
Even as Washington’s attention careens from one fiscal showdown to the next—which is reasonable with $85 billion in spending cuts due to go into effect in just a few days coming on the heels of December’s Fiscal Cliff–many manufacturers also await what could be an avalanche of regulations to implement the infamous Dodd-Frank Wall Street Reform Act that could prove to bury these derivatives end-users in excessive costs and regulatory burdens to “fix” aspects of the financial crisis that they neither caused nor contributed to.
For the past two and a half years since the passage of this voluminous statute, a number of unintended consequences of the 850 page statute have come to light as derivatives end-users—who use derivatives as a way to manage commercial risk and NOT for speculative purposes—come to recognize how their day to day business practice might be caught up in a slew of regulations from an array of regulators. These rulemakings have the potential to undo best practices, efficiencies and risk management strategies to improve business functions.
To combat this, for the past several years the NAM has served as a steering committee member of the Coalition for Derivatives End-Users working with a coalition of business associations and hundreds of end-user companies to mitigate the impact on end-users of Dodd-Frank’s implementation. The NAM drove an effort during the lame duck Congressional session to seek passage of two bills critical to manufacturers that use derivatives to manage risk. The effort has served as a springboard for the Coalition’s activity this year.
Already this year, the Coalition has met with the staff, the Chairman of the CFTC as well as several of the Commissioners seeking relief from two of the most time sensitive concerns facing end-users including: the upcoming deadline of April 10th when, without no-action relief from the CFTC, end-users will need to begin reporting their inter-affiliate trades to a swap data repository within 48 hours of the trade; and, a June 10th deadline financial institutions are required to begin clearing trades – a deadline that will impact end-users who use centralized hedging centers to centralize inter-affiliate trades and use that hedging center to conduct external trades unless the CFTC provides exemptive relief to these centralized hedging units of non-financial end-users. The Coalition is working this week to submit requests for these relief actions to the CFTC.
Simultaneously, we continue our legislative effort and already this year the two priority end-user bills – one providing a clear end-user exemption from margin requirements and one exempting inter-affiliate trades from being treated in the same manner as external, market facing trades and rectifying the centralized hedging center issue described above. Those bills, H.R. 634 and H.R. 677, were introduced earlier this month in the House by bipartisan groups of members of both the House Agriculture and House Financial Services Committees–and we hope there will be companion legislation introduced in the Senate in the near term.
The NAM continues to lead both legislative and regulatory solutions to address the challenges facing end-users. Company participation in these efforts is critical to make the case for action and the NAM will continue to coordinate opportunities for members to weigh in on these matters.
Excellent statement Wednesday from Craig Reiners, director of risk management for MillerCoors LLC before the House Financial Services Committee’s hearing, “Assessing the Regulatory, Economic and Market Implications of the Dodd-Frank Derivatives Title.”
Reiners was testifying on behalf of the Coalition for Derivative End-Users — to which the National Association of Manufacturers belongs — about the use of derivatives by manufacturers to manage risk . Excerpt (with our paragraph breaks):
MillerCoors uses derivatives for the sole purpose of reducing commercial risk associated with our business. At MillerCoors, we brew beer, and our commitment to our customers is to produce the best beer in the United States and to deliver it at a competitive price. In order to achieve these goals, we must find a way to mitigate and prudently manage our inherent commodity risks. I believe the prudent use of derivatives offers end-users of physical commodities the critical risk management tools to provide a necessary degree of predictability to our earnings. The derivatives our organization has approved for use provide the tools to manage volatility intrinsic to commodities, which allows us to manage cash flow expectations within reasonable parameters. Our single largest commodity exposure is to aluminum. Our agricultural risks include malting barley, corn and hops. Our energy risk portfolio includes coal, natural gas, deregulated electricity and diesel fuel. This annual commodity spend of over $2.8 billion must be prudently managed.
In order to properly manage this significant risk, we created a strict Board-approved commodity risk policy that clearly forbids speculation. This policy allows us to use OTC swaps to precisely match the timing and prices of our complex manufacturing and distribution process. For example, we exactly match our OTC swaps for aluminum with our actual use of cans over the same time frame. This risk management technique allows us to prudently manage our costs and reduce price volatility.
We have used this risk management process both prior to and since the inception of MillerCoors with no adverse consequences. In fact, we would create significantly more price volatility in our business by not hedging our business risks. We believe that end-users generally share the concern that if the cost of hedging our risks rises significantly, entering into swaps may no longer be economical. The result could be a reduction in risk mitigation through hedging, which, ironically, could increase risk and exposure to market volatility.
Sen. Mike Johanns (R-NE) and 12 other U.S. Senators recently wrote a letter to the Securities and Exchange Commission urging the SEC to make sure that new regulations not limit the legitimate use of derivatives as a risk-management tool. The Coalition had encouraged Senators to join the letter, noting the potentially painful economic effects of overregulation:
A Business Roundtable survey from last year demonstrated that the imposition of a 3% initial margin requirement on S&P 500 companies alone would drain $269 million in liquidity per company and could reduce capital spending by $5 to $6 billion per year, causing a loss of 100,0000 to 120,000 jobs. Expanding this data to include non-S&P 500 companies and to account for variation margin requirements would substantially increase job losses.
News coverage …
- Washington Post, “Corporate groups, Republicans call Dodd-Frank derivative rules bad for business“
- Politico, “Business aims at derivatives rules“
- Wall Street Journal, Corporate Groups Attack Unintended Consequences Of Dodd-Frank
The House of Representatives appointed conferees Wednesday to H.R. H.R. 4173, the Wall Street Reform and Consumer Protection Act, i.e., the financial regulation bill. The conference committee work will begin in earnest next week, and the National Association of Manufacturers and other business groups are still very concerned about proposed language on derivatives.
The Wall Street Journal reports today, “Democrats Spar Over Derivatives Rules“:
WASHINGTON—Democratic efforts to swiftly steer a financial-overhaul bill into law stumbled as House and Senate leaders clashed over how best to regulate the $600 trillion derivatives market.
The question, while highly technical, is a central component of the bill and would have wide-ranging consequences for U.S. businesses that use the complex financial instruments to protect themselves from fluctuations in currencies, interest rates and commodity prices.
The Journal notes the NAM letter sent Thursday to the conference committee highlighting manufacturers’ views on the legislation, emphasizing the need to preserve the ability of end users to use derivatives to manage risk. The broad point:
The National Association of Manufacturers (NAM) – the nation’s largest industrial trade association – appreciates and supports the efforts of policymakers to improve transparency, accountability and stability in our nation’s financial system. As you work to craft a compromise version of the Wall Street Reform and Consumer Protection Act (H.R. 4173), we urge you to focus on strengthening the U.S. financial system and avoiding new regulations that could be costly and could hinder job creation for manufacturers and other non-financial companies that had nothing to do with the financial crisis.
While the National Association of Manufacturers has made the investment-discouraging derivatives provisions of the financial regulation bill its focus of attention, S. 3217, other sections of the bill would also add uncertainty and increase the costs of doing business in the United States. The Washington Post, among others, caught up on those provisions over the weekend. For example, there’s the corporate governance language, which would allow special-interest groups like organized labor and environmentalists to force their political agendas upon stockholders.
A rush of chief executives from a wide swath of industries has been coming through Washington over the past three weeks, talking to lawmakers about a long-debated issue called “proxy access,” which would make it easier for shareholders at all publicly traded companies — not just banks — to nominate board directors. Opponents say the rule has nothing to do with overhauling Wall Street and doesn’t belong in the legislation.
“This is our highest priority,” said John Castellani, president of the Business Roundtable, which represents 170 chief executives. “Literally all of our members have called about this.”
The NAM and other business groups signed a joint letter to Congress last month sharply opposing the provisions.
The consumer protection provisions of the financial regulation bill also represent a major expansion of government control over the economy, directly through the federal government as well as indirectly — and potentially even more damaging — through state attorneys general and their political allies in the plaintiffs’ bar. The Post’s story, “Lawmakers, financial firms push to limit state power on consumer protection,” reports on the efforts by Sen. Tom Carper (D-DE) to rein in the most harmful elements in the bill.
Carper said he shares the White House’s goal of establishing a new consumer protection bureau to guard against fraud and deceptive practices.
“All my amendment says is that we should make that bureau do its job. This is the cop on the beat that we need,” Carper said. He warned that if state regulators are also allowed to pursue cases against national banks, this would cause confusion as consumer protection rules are interpreted differently by dozens of separate governments.
Carper’s amendment, which would limit the ability of state attorneys general to enforce federal law against national banks, has more than a dozen sponsors on both sides of the aisle. It could come up for debate early next week.
Sen. Carper’s amendment is S.Amt. 3949, and the text is available here.
The NAM has also opposed Sen. Specter’s amendment to expand liability in securities fraud litigation to parties not involved in the fraud, i.e., his attempt to overturn the U.S. Supreme Court’s ruling in Stoneridge v. Scientific Atlanta. On Thursday, Sen. Specter (D-PA) urged his colleagues cosponsoring the amendment to come to the Senate floor in support of it, but according to the Congressional Record, none did. The Senate is expected to vote on amendments this evening, but it seems safe to say the Specter amendment will not be considered until after the results of the Pennsylvania primary election on Tuesday. If Senate Majority Leader Reid files cloture on the entire 1,400-page bill today, as reported, then the Stoneridge amendment may be stone dead. That would be good.