Gensler Staring Down Administration and Banks on Derivatives Reform

Yves here. Readers may recall that Gary Gensler, the head of the Commodities Futures Trading Commission, is being pushed out by Obama. His planned replacement is so appallingly lightweight (oh, and formerly in a very junior role at Goldman) as to assure that all she’ll be able to do is take dictation from financial firm lobbyists.

But Gensler may be having a last laugh before he leaves office. The proximate reason for his ouster was that he was refusing to accede to the demands of banks and foreign regulators over implementation of Dodd Frank rules on swaps. As we wrote earlier this month:

Shahien Nasiripour at the Huffington Post describes how Gensler is being ousted for his position on swaps regulation, which was coming to a head in international meetings starting June 20, with a July 12 deadline looming. The industry was pushing for the usual “race to the bottom” approach, since the Dodd Frank provisions are more stringent than overseas requirments (the spin, of course, was that Gensler was acting unilaterally, as opposed to implementing what Congress mandated). Gensler faces varying degrees of resistance from three of his four fellow commissioners. International regulators were apparently also unhappy with Gensler’s tough stand, to the point where they were complaining to Treasury Secretary Jack Lew.

And bear in mind that the reason the banks are howling like stuck pigs is that the businesses in question are are significant profit sources. The International Financial Review gives an idea of the implications if Gensler hangs tough:

Figures from the US Treasury show that US financial institutions reported derivatives trading revenues of US$4.4bn in the fourth quarter of 2012, a 73% increase on the previous year.

These revenues were dominated by JP Morgan, Bank of America Merrill Lynch, Citigroup and Goldman Sachs. And analysts estimate that US banks route around 50% of their derivatives trades overseas, which would mean a sea change for their operations, not to mention their bottom lines, if the exemption was allowed to die.

“US banks simply aren’t ready to lose this exemption. It will cost them a considerable amount,” the first lawyer said. “Even just the logistical challenge of reorganising their trading business will be enormous, and they are likely to lose clients because of it.”

George Bailey, via e-mail, describes how Gensler is in a position to prevail in this important but largely unnoticed regulatory battle.

By George Bailey, who has worked in senior compliance roles at Big Firms You’ve Heard Of and is also a member of Occupy the SEC

Gary Gensler is under attack by the Administration, US trade negotiators, Eurocrats, the bank lobby, Congress, other regulators, and most of his fellow Commisioners for soldiering on and implementing the rules required by the Dodd Frank Act.

This fight comes to a head on July 12. That is when the CFTC’s ‘exemptive relief’ from complying with Dodd Frank rules expires for major players in the derivatives markets. If the exemption is not extended, all these players become subject to more stringent capital requirements and reporting. They’ve all assumed that the Administration would give them the waivers they wanted, or at worst water down Dodd Frank to their liking. Gensler’s refusal to back down has caught them unprepared for possible major rule changes.

The groups affected are:

Foreign branches of US banks (where > 50% of US banks derivatives activity takes place)
The International Financing Review describes the consequences for US banks:

Several sources familiar with the internal discussions at the Commodity Futures Trading Commission say that the current exemption – which allows US banks executing derivative trades outside the country to bypass tougher capital holding and reporting requirements – will be allowed to expire on July 12

“All of these common sense reforms Congress mandated … could be undone if the overseas guaranteed affiliates and branches of US persons are allowed to operate outside of these important requirements,” he (Gensler) said in a June 6 speech.

Those words shocked some who thought the extension was virtually a fait accompli.

To further complicate matters, the expiry of the exemption would effectively mean that Dodd-Frank legislation would be regulating the activity of US banks based abroad. So while European regulators obviously do not want their banks to be substantially less competitive, they also do not want the grasp of US regulators reaching into their jurisdiction.

CFTC registered foreign swap dealers may be required to comply with the full set of US CFTC rules, because their home country regulators have not kept pace and adopted comparable home country rules in time

The definition of US persons, which currently exempts US funds run out of Cayman and other offshore locations from Dodd Frank, is likely to be clarified to close that loophole, if Commisioner Chilton gets his way. In a recent speech he warned the hedge fun community to beware.

You guys from the Caymans or Connecticut may want to listen up. I don’t want to get in the way of the funds industry doing what it does best: finding opportunities for clients wherever in the world those opportunities might lie. With this and Congress’s goals in mind, here are some of my thoughts on the cross-border guidance as they relate to you guys in particular.

First, the Commission should give a clear interpretation of “principal place of business.” A firm should only have one “principal place of business.” The broader the set of factors we use to assign a “principal place of business” the more difficult it becomes to pin down where exactly is a fund’s “principal place of business.” My mantra on most of these rules is to keep it simple. Let’s focus on what really matters in clarifying this term. If there’s simply a post office box or little more, that won’t cut it as a principle place of business in my book. Where is your head office? Where are your executives and trading managers located? That’s what we need to consider.

PriceWaterhouse Coopers prepared an explainer of Dodd Frank cross border derivatives rules conflicts, for anyone looking for an accessable layman’s version of the issues involved in the current state of play.

Preparedness scheduling was predicated on the assumption that Gensler would extend the relief period. It may already be too late implement the operational changes necessary to comply with the regulations. There is a lot of anxiety on Wall Street, in DC, and in Europe.

Gensler hasn’t given any indication he intends to back down. Industry, regulators and government policy makers all expected this to have the rules finalized months ago. Instead it’s turned into a multi dimensional game of chicken. His fellow commissioners are in open revolt so concensus within the CFTC appears to be unlikely. Absent an extension, everyone will be out of compliance and in uncharted legal territory come July 12. Gensler has, so far, refused to put an extension on the agenda for a vote. He controls the agenda as Chairman.

The Europeans are so incensed they took to scolding the CFTC Chairman in an op-ed by Michel Barnier, in Bloomberg. Dennis Kelleher of Better Markets did a fine job if debunking this extraordinary display of pique.

The Bloomberg piece did serve notice to anyone who isn’t paying attention, that the gutting of Dodd Frank is scheduled to be handled in the current round of trade negotiations on financial markets. In case you missed it, here’s the money quite from Michael Barnier

Cooperation and mutual reliance, not confrontation, will protect investors and taxpayers far better than duplication and protectionism. The creation of such a binding, and mutually beneficial, framework is one of the main reasons Europe wants financial-services regulation to be included in the negotiations toward a free-trade agreement with the U.S. that begin in July.

Since the trade agreement is designed to trump the regulations (and the laws underlying them) we’d better play pretty close attention to the negotiations. Good luck with that, as Elizabeth Warren has been learning.

Yves again. This fight appears to be an alliance of US megafirms, with Rubinites leading the charge, plus undercapitalized Eurobanks. I’d welcome informed reader input, but the Brits don’t seem to be prominent in this struggle.

And it isn’t clear how this winds up. Given the refusal of the major players to prepare for the deadline, and Gensler’s control of the agenda (as in refusal to table an extension) he can dictate terms. If he does nothing, the industry will be forced into workarounds, with one of the likely results that some activity will move to regulated exchanges. That may well be Gensler’s aim, particularly since one past crisis, the LTCM meltdown, would likely not have occurred had the hedge fund been forced to conduct interest rate swaps transactions on an exchange (the hedge fund had taken an astonishing 10% of the interest rate swaps market, which was too large a position to exit gracefully, and when the rest of the Street figured out how exposed it was, they took advantage of its distress).

In the past, Gensler has gone for 11th hour compromises, but given that this is likely to be his last act, he might prove to more bloodyminded than before. Stay tuned.

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  1. psychohistorian

    What kind of car does Gensler drive?

    It sure is nice to read about all these hot buttons being pushed by principled folks.

    Where is the principled Fed insider that tells the world how “global finance” really works?

  2. Clive

    A lot of the nastiest derivative positions held by the UK TBTFs have been given a lipstick-on-a-pig treatment of being classed as “held to maturity”. This takes the worst of the capital requirements sting out of them, hence the absence of kicking up a fuss. Of course, it’s just window-dressing the balance sheet… but retail muppets do rather get taken in by the chenille curtains and pretty flowers even if the rest of the building is subsiding with cracks disguised by Puttyfilla.

    The remainder are, frankly, too dumb to understand their treasury operations so are blissfully ignorant. You would not believe (then again, maybe you would) how thick the top management of the indigenous UK TBTFs is. At least Jamie Dimon is smart, if nothing else. Bob Diamond was too. There are times when I think a lobotomy was an entry requirement to becoming a UK TBTF CEO. Especially when it comes to managing their treasury operations.

  3. C

    Boy it’s refreshing to see someone doing their job for a change. It reminds me of Obama’s efforts to replace the head of the Nuclear Regulatory Commission for, well making nuclear power companies sad.

    Given that Gensler’s already-demonstrated willingness to do so will keep him from getting any other cushy appointment and that his replacement will undo anything he does I suggest he go to the limit. It may be the only way to have any lasting effect.

    Of course in light of this* I feel so confident that the Civil Liberties Panel composed of Obama Appointees with no staff and no investigative powers will do such a great job overseeing the NSA!


  4. Conscience of a Conservative

    Gensler is a real breath of fresh air and a shock, having come from Goldman Sachs & being part of the Summers, Geithner, Rubin regime from Clinton days, but Gensler has had a true mea culpa on derivative regulation, something that Obama apparently quite doesn’t get.

  5. AbyNormal

    Question Yves…i recently read “the comptroller granted banks two more years to move derivative trades into separate units that are walled off from the rest of the bank. The “swaps push-out” rule bars those affiliates from accessing the Federal Reserve’s emergency-lending facilities or relying on federal deposit insurance.”
    i was shocked an dismayed with the comptrollers reach…my question is how much muscle and reach can Dodaro exercise pertaining to Gensler’s exiting ruling(s).

        1. AbyNormal

          i guess it is a stupid question. i’m just unaware of how much authority the OCC has when it comes to CFTC business/rulings.

          1. Chauncey Gardiner

            Not a stupid question IMO, Aby, and I too wish I knew the answer from both a legal and practical standpoint.

          1. jake chase

            Bought them new cars, houses, diamonds, trips to Europe…….I once figured out I could have saved $3 million by being celibate for the last forty years.

  6. jake chase

    Gensler, Shmensler. This food fight amounts to arguing about religious dogma. ‘Capital requirements’ impose no serious limits on banks’ derivative betting, and any ‘reform’ which does not outlaw derivative bets by insured institutions is meaningless. Any ‘profits’ realized from derivative bets are phony in the sense that they expose the institution to uninsurable (and incalculable) risks which must inevitably require bailout after another, as the only alternative to bankruptcy.

    Dodd Frank does nothing to change this. Why not start just telling this story straight from the shoulder?

    1. Yves Smith Post author

      With all due respect, you don’t appear to understand what you are talking about. Banks are going to have huge problems if Gensler hangs tough. The article clearly states they will have to do workarounds and will lose business, and will have to migrate some, perhaps a lot, of their current business to exchanges. You evidently don’t grok that that means a big reduction in fees to them due to 1. More price transparency and 2. Loss of margin (OTC spreads higher than brokerage fees).

      This is not a nothingburger. It will reduce the size of the OTC business if Gensler does not relent. That’s a desirable outcome.

      We need to give regulators credit when they do stand up to the industry, otherwise, why should they bother? But you’d rather undermine that out of your idee fixe that Dodd Frank did nothing. It didn’t do enough by a long shot but this is one area where it could have a positive impact.

      1. jake chase

        I hear the same bs from a banker who makes her living orchestrating tax evasion for one of the biggies. So long as we allow insured deposits to be leveraged in derivative trading, the only issue will be the size of the banker bonuses and the interregnum to the next bank bailout.

        One doesn’t don’t need an encyclopedic knowledge of the details and there are better things to do with one’s time than acquire it. Sorry if this offends you.

        1. run75441


          I agree with the installation of a fire wall between depository banking and Wall Street gambling would go a long way to forestalling another 2008 meltdown; but, I also would state you have to start somewhere and Gensler’s actions are better than nothing in forcing the OTC derivative market to conform.

        2. sgt_doom

          Once again I must fully agree with JC and remark that Yves sounds like a PR flack for McKinsey; this is simply parsing the econopolypse! (Curious to see if she will be censoring this comment as others have been censored?)

        3. Yves Smith Post author


          From your initial and your second comment, it appears you don’t even understand the implications of what Gensler did, or just got reflexively angry at the idea any regulator might be depicted as making an effective move.

          If the regulations force work-arounds, that will make them more costly and reduce the size of the market. Or customers will move the transactions to different institutions altogether, like (horrors) non-banks or futures exchanges. Most people deem exchanges to be one of the best solutions. “Moving them to exchanges” means they are not longer at the bank AT ALL. The bank is acting like a mere broker, he’s not putting them on his balance sheet at all and therefore not using deposits.

          If either of these happen (and it looks like both will happen), that reduces the amount of derivatives carried on the banks’ balance sheets, potentially by a LOT.

          Your beef makes no sense. You are basically saying unless you get a 100% solution to the problem, don’t take any measures that make things better. Is that REALLY your view?

          If you are gonna attack Gensler, the better route is “this tough guy stuff is all well and good, let’s see if he’s held his ground on July 13.”

          1. jake chase

            Which exchange do you expect to handle the $600 trillion in credit default swaps? You might as well attempt to bring down the Luftwafe with fly swatters. The banks are only upset about Gensler because they might have to spend more frequent flyer miles moving liabilities offshore to evade the capital rules. How can you believe the CFTC has any chance of impacting the swaps business? Just wait until Ms. Cha Cha Renteria starts taking dictation from the lobbyists while trying to keep her cabeza above the agua.

  7. JEHR

    What a pleasant surprise Gensler has proven to be! It is refreshing to know that there are people in public service who are actually trying to regulation derivatives. I hope he prevails.

  8. AbyNormal

    why are you posting to a sight you so vehemently disagree with? this makes no more sense than you post. the answer must resides in your dna…

    Belief and delusion are incestuous siblings.”
    hemon, the lazarus project

  9. Chauncey Gardiner

    Thank you for pointing out how Gensler is under attack by U.S. trade negotiators on this potentially very damaging issue… Ya know, where we’re potentially liable to a foreign bank for their derivatives losses that stem from policy changes or U.S. counterparties.

    Disgusting that the terms of these agreements are not being made public.

  10. allcoppedout

    The BoE has collected a lot of recent work on OTC derivatives here –
    There are 247 pages and many bibliographies.

    None of this seems to get to Yves’ point on the cut-up of the pie and who will be able to extract fees. Typically global agreement is stressed as key, something even the Mayor of Toytown could work out.
    is an attempt to summarize the transatlantic differences in new regulation by Karel Lannoo.

    My feeling reading these papers is that the banks will get inside any legislation in such a way as to raise their prices, claiming transparency will cause new liquidity costs to be born by their customers and typically contracts will continue to include yards of legalese before the small print starts so no one knows what they are buying.

    1. Yves Smith Post author

      Um, you are missing the key point here.

      They have NOT “gotten inside the legislation” or in this case, the rule making.

      Gensler controls the agenda at the CFTC and so far he is not allowing a fix to give them time to offer proposals to water down Dodd Frank.

      If he does not relent the new rules come into effect. Banks will need to change behavior. They’ve made no preparation for that and now they are trying to make that Gensler’s problem. So far, he’s not buying that.

      1. readerOfTeaLeaves

        It’s a breath of fresh air to see someone use a Chair position (in this case of CFTC) to set the agenda in a fashion that serves the public interest.

        It’s also interesting to see the banks **assume** that they’ll get their way, and consequently risk getting caught in muddles because they didn’t even bother to consider the remote possibility that the reforms might actually get through.

        I sincerely hope Mr Gensler (and, I assume Mr Chilton) are enjoying the hell out of themselves in this mudfight. It’s nice to win once in a great while.

      2. Mr. Jack M. Hoff

        Yves, you seem to imply that banks actually abide by laws. Thanks for the good laugh. Its been plain as day for the last 6 years that they will not be prosecuted for any lawbreaking whatsoever, Yeah, they may be required to pay a small percentage of the take, but they are certainly not prevented from breaking the same laws over and over again. Now please tell me why you think this times gonna be any different? Thats what I just don’t get about you….

  11. Nat Scientist

    All he wants to do is defang the Banks from inventing credit, then margin-calling when the free money dealers flash-collapses that phony credit and collecting the client’s position for pennies, then hold any mistakes to any hypothecated maturity that presents on the Fed’s arm. That’s All, Folks.

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