[Congressional Record Volume 156, Number 109 (Thursday, July 22, 2010)]
[Senate]
[Pages S6192-S6193]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                         TREATMENT OF END USERS

  Mrs. LINCOLN. Mr. President, I ask unanimous consent to have printed 
in the Record a letter dated June 30, 2010, from Senator Dodd and me to 
House Chairmen Peterson and Frank regarding the treatment of end users 
in the Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 
4173.
  There being no objection, the material was ordered to be printed in 
the Record, as follows:

                                                  U.S. Senate,

                                    Washington, DC, June 30, 2010.
     Hon. Chairman Barney Frank,
     Financial Services Committee, House of Representatives, 
         Rayburn House Office Building, Washington, DC.
     Hon. Chairman Collin Peterson,
     Committee on Agriculture, House of Representatives, Longworth 
         House Office Building, Washington, DC.
       Dear Chairmen Frank and Peterson: Whether swaps are used by 
     an airline hedging its fuel costs or a global manufacturing 
     company hedging interest rate risk, derivatives are an 
     important tool businesses use to manage costs and market 
     volatility. This legislation will preserve that tool. 
     Regulators, namely the Commodity Futures Trading Commission 
     (CFTC), the Securities and Exchange Commission (SEC), and the 
     prudential regulators, must not make hedging so costly it 
     becomes prohibitively expensive for end users to manage their 
     risk. This letter seeks to provide some additional background 
     on legislative intent on some, but not all, of the various 
     sections of Title VII of H.R. 4173, the Dodd-Frank Act.
       The legislation does not authorize the regulators to impose 
     margin on end users, those exempt entities that use swaps to 
     hedge or mitigate commercial risk. If regulators raise the 
     costs of end user transactions, they may create more risk. It 
     is imperative that the regulators do not unnecessarily divert 
     working capital from our economy into margin accounts, in a 
     way that would discourage hedging by end users or impair 
     economic growth.
       Again, Congress clearly stated in this bill that the margin 
     and capital requirements are not to be imposed on end users, 
     nor can the regulators require clearing for end user trades. 
     Regulators are charged with establishing rules for the 
     capital requirements, as well as the margin requirements for 
     all uncleared trades, but rules may not be set in a way that 
     requires the imposition of margin requirements on the end 
     user side of a lawful transaction. In cases where a Swap 
     Dealer enters into an uncleared swap with an end user, margin 
     on the dealer side of the transaction should reflect the 
     counterparty risk of the transaction. Congress strongly 
     encourages regulators to establish margin requirements for 
     such swaps or security-based swaps in a manner that is 
     consistent with the Congressional intent to protect end users 
     from burdensome costs.
       In harmonizing the different approaches taken by the House 
     and Senate in their respective derivatives titles, a number 
     of provisions were deleted by the Conference Committee to 
     avoid redundancy and to streamline the regulatory framework. 
     However, a consistent Congressional directive throughout all 
     drafts of this legislation, and in Congressional debate, has 
     been to protect end users from burdensome costs associated 
     with margin requirements and mandatory clearing. Accordingly, 
     changes made in Conference to the section of the bill 
     regulating capital and margin requirements for Swap Dealers 
     and Major Swap Participants should not be construed as 
     changing this important Congressional interest in protecting 
     end users. In fact, the House offer amending the capital and 
     margin provisions of Sections 731 and 764 expressly stated 
     that the strike to the base text was made ``to eliminate 
     redundancy.'' Capital and margin standards should be set to 
     mitigate risk in our financial system, not punish those who 
     are trying to hedge their own commercial risk.
       Congress recognized that the individualized credit 
     arrangements worked out between counterparties in a bilateral 
     transaction can be important components of business risk 
     management. That is why Congress specifically mandates that 
     regulators permit the use of non-cash collateral for 
     counterparty arrangements with Swap Dealers and Major Swap 
     Participants to permit flexibility. Mitigating risk is one of 
     the most important reasons for passing this legislation.
       Congress determined that clearing is at the heart of 
     reform--bringing transactions and counterparties into a 
     robust, conservative and transparent risk management 
     framework. Congress also acknowledged that clearing may not 
     be suitable for every transaction or every counterparty. End 
     users who hedge their risks may find it challenging to use a 
     standard derivative contracts to exactly match up their risks 
     with counterparties willing to purchase their specific 
     exposures. Standardized derivative contracts may not be 
     suitable for every transaction. Congress recognized that 
     imposing the clearing and exchange trading requirement on 
     commercial end-users could raise transaction costs where 
     there is a substantial public interest in keeping such costs 
     low (i.e., to provide consumers with stable, low prices, 
     promote investment, and create jobs.)
       Congress recognized this concern and created a robust end 
     user clearing exemption for those entities that are using the 
     swaps market to hedge or mitigate commercial risk. These 
     entities could be anything ranging from car companies to 
     airlines or energy companies who produce and distribute power 
     to farm machinery manufacturers. They also include captive 
     finance affiliates, finance arms that are hedging in support 
     of manufacturing or other commercial companies. The end user 
     exemption also may apply to our smaller financial entities--
     credit unions, community banks, and farm credit institutions. 
     These entities did not get us into this crisis and should not 
     be punished for Wall Street's excesses. They help to finance 
     jobs and provide lending for communities all across this 
     nation. That is why Congress provided regulators the 
     authority to exempt these institutions.
       This is also why we narrowed the scope of the Swap Dealer 
     and Major Swap Participant definitions. We should not 
     inadvertently pull in entities that are appropriately 
     managing their risk. In implementing the Swap Dealer and 
     Major Swap Participant provisions, Congress expects the 
     regulators to maintain through rulemaking that the definition 
     of Major Swap Participant does not capture companies simply 
     because they use swaps to hedge risk in their ordinary course 
     of business. Congress does not intend to regulate end-users 
     as Major Swap Participants or Swap Dealers just because they 
     use swaps to hedge or manage the commercial risks associated 
     with their business. For example, the Major Swap Participant 
     and Swap Dealer definitions are not intended to include an 
     electric or gas utility that purchases commodities that are 
     used either as a source of fuel to produce electricity or to 
     supply gas to retail customers and that uses swaps to hedge 
     or manage the commercial risks associated with its business. 
     Congress incorporated a de minimis exception to the Swap 
     Dealer definition to ensure that smaller institutions that 
     are responsibly managing their commercial risk are not 
     inadvertently pulled into additional regulation.
       Just as Congress has heard the end user community, 
     regulators must carefully take into consideration the impact 
     of regulation and capital and margin on these entities.
       It is also imperative that regulators do not assume that 
     all over-the-counter transactions share the same risk 
     profile. While uncleared swaps should be looked at closely, 
     regulators must carefully analyze the risk associated with 
     cleared and uncleared swaps and apply that analysis when 
     setting capital standards for Swap Dealers and Major Swap 
     Participants. As regulators set capital and margin standards 
     on Swap Dealers or Major Swap Participants, they must set the 
     appropriate standards relative to the risks associated with 
     trading. Regulators must carefully consider the potential 
     burdens that Swap Dealers and Major Swap Participants may 
     impose on end user counterparties--especially if those 
     requirements will discourage the use of swaps by end users or 
     harm economic growth. Regulators should seek to impose 
     margins to the extent they are necessary to ensure the safety 
     and soundness of the Swap Dealers and Major Swap 
     Participants.
       Congress determined that end users must be empowered in 
     their counterparty relationships, especially relationships 
     with swap dealers. This is why Congress explicitly gave to 
     end users the option to clear swaps contracts, the option to 
     choose their clearinghouse or clearing agency, and the option 
     to segregate margin with an independent 3rd party custodian.

[[Page S6193]]

       In implementing the derivatives title, Congress encourages 
     the CFTC to clarify through rulemaking that the exclusion 
     from the definition of swap for ``any sale of a nonfinancial 
     commodity or security for deferred shipment or delivery, so 
     long as the transaction is intended to be physically 
     settled'' is intended to be consistent with the forward 
     contract exclusion that is currently in the Commodity 
     Exchange Act and the CFTC's established policy and orders on 
     this subject, including situations where commercial parties 
     agree to ``book-out'' their physical delivery obligations 
     under a forward contract.
       Congress recognized that the capital and margin 
     requirements in this bill could have an impact on swaps 
     contracts currently in existence. For this reason, we 
     provided legal certainty to those contracts currently in 
     existence, providing that no contract could be terminated, 
     renegotiated, modified, amended, or supplemented (unless 
     otherwise specified in the contract) based on the 
     implementation of any requirement in this Act, including 
     requirements on Swap Dealers and Major Swap Participants. It 
     is imperative that we provide certainty to these existing 
     contracts for the sake of our economy and financial system.
       Regulators must carefully follow Congressional intent in 
     implementing this bill. While Congress may not have the 
     expertise to set specific standards, we have laid out our 
     criteria and guidelines for implementing reform. It is 
     imperative that these standards are not punitive to the end 
     users, that we encourage the management of commercial risk, 
     and that we build a strong but responsive framework for 
     regulating the derivatives market.
           Sincerely,
     Chairman Christopher Dodd,
       Senate Committee on Banking, Housing, and Urban Affairs, 
     U.S. Senate.
     Chairman Blanche Lincoln,
       Senate Committee on Agriculture, Nutrition, and Forestry, 
     U.S. Senate.

     

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