AFP Blogs

Senate Banking Committee Chairman Chris Dodd (D-CT) unveiled a new bill to systematically reform the financial regulatory structure of our nation’s capital markets. The Restoring American Financial Stability Act attempts to “create a sound economic foundation to grow jobs, protect consumers, rein in Wall Street, end too big to fail institutions, and to reform the financial regulatory system”.  Chairman Dodd released both a summary describing the bill, as well as the full text of the 1,300+ page legislative language.  Senator Dodd has announced that he will entertain a substantive amendment to the derivatives section of this bill.  It is very likely that the derivatives language included in this bill is not the final version.

AFP staff is currently digesting the contents of the bill and will provide analysis on areas of importance to AFP members.  Be sure to check AFPonline.org for additional stories on regulatory reform. Or, contact me at jarnett@AFPonline.org.

OTC derivatives reform was the topic of a Senate Agriculture Committee hearing Wednesday. Treasury Secretary Timothy Geithner was among the witnesses to testify. Also on the list: Jiro Okochi, CEO of Reval, a derivative risk management and hedge accounting provider. Okochi told the full Ag Committee how the proposed legislation would impact derivatives end users.

“That was my first time testifying before Congress and it was quite an honor and privilege,” he said. “The consensus I sensed from the Senators’ questions to me and Geithner’s responses to their questions was they understand there needs to be special considerations for end users. The senators clearly recognize that end users weren’t to blame so hopefully the bill will have fairly broad exemptions.”

Okochi proposed adding a risk management policy stipulation to the legislation to avoid Congress creating carveouts — or, worse, leaving carveouts up to regulators. He also suggested exempting derivatives younger than 12 months, including FX forwards and swaps, single-currency interest rate swaps and commodity swaps that don’t physically settle. “These one-year swaps generally don’t pose much systemic risk,” said Okochi, who also reminded the committee that not exempting swaps sold for margining and capital will lead to the margining being passed on to the corporates, “which defeats the purpose,” he said.

The general counsel of the U.S. Commodity Futures Trading Commission, corporate treasury and finance executives from Verizon and Tiffany & Co., and legislators are slated to speak at an OTC derivatives reform update hosted by AFP.

CFTC General Counsel Dan Berkovitz, Verizon Director of Investment Strategy and Risk Management Neil O’Sullivan, CTP, and Tiffany & Co. VP Treasurer Michael Connolly will offer their perspectives on proposed OTC derivatives reform currently before Congress, December 7, in New York City. Registration is free, but seating is limited. The three-hour event starts at 8 a.m. at the Roosevelt Hotel in midtown Manhattan. This event is approved for three CTP/CCM credits.

AFP staff also will host an update and open forum on OTC derivatives reform in Chicago on December 4. Registration is free, but seating is limited. The three-hour event starts at 8 a.m. CT and is at the Hyatt Regency O’Hare.

“The situation around OTC derivatives reform is extremely fluid so these events are very timely,” says Brian Kalish, AFP Director, Finance Practice Lead. “It’s important for corporate treasury and finance executives to understand where we’re headed, and it’s an opportunity for legislators and regulators to hear from corporate end users.”

For more information about both OTC derivatives events contact Julianne Franck.

Senate Banking Committee Chairman Chris Dodd (D-CT) unveiled his bill to systematically reform the financial regulatory structure of our nation’s capital markets. The Restoring American Financial Stability Act of 2009 attempts to “restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them”, said Sen. Dodd in a summary describing 1,100+ page bill. AFP staff is digesting the contents of the bill and will provide analysis on areas of importance to AFP members.  Be sure to check AFPonline.org for additional stories on regulatory reform. Or, contact me at jarnett@AFPonline.org.

My colleague, Brian Kalish, has a typically thoughtful article in the November issue of Risk. “One of the new risks associated with our recent financial crises is political risk,” writes Kalish, AFP’s Director, Finance Practice Lead. “While political risk has always existed, the focus has tended to be at the macro-level and outside of the United States. Starting in the summer of 2007, there has been a greater awareness of political risk at the micro-level and inside the boundaries of the United States.”

Political risk now means more than a coup in a far-off nation, Kalish writes. For corporate treasury, it means the uncertainty brought about by the federal government’s unprecedented intervention into the U.S. economy — especially the financial world. That political risk will continue into 2010 as President Obama’s financial regulatory overhaul proposal winds through Congress. Kalish has the final word: “Going forward, companies will have to incorporate the higher cost associated with a higher degree of political uncertainty.”

You can access Risk here.

Your firm just suffered its worst year in history and you’re scrambling to improve risk management. What’s the solution? Spend more on IT.

That’s a key suggestion from a report by the Senior Supervisors Group (SSG), a gathering of regulators from the U.S. (including the Fed, OCC, SEC and the New York Fed Bank), Canada, France, Germany, Japan, Switzerland and the UK:

Overall, the crisis highlighted the inadequacy of many firms’ IT infrastructures in supporting the broad management of financial risks. In some cases, the obstacle to improving risk management systems has been the poor integration of data that has resulted from firms’ multiple mergers and acquisitions. This problem has been seen as affecting firms’ ability to implement effective transfer pricing, consistently value complex products throughout an organization, estimate counterparty credit risk (CCR) levels, aggregate credit exposures quickly, and perform forward-looking stress tests. Building more robust infrastructure systems requires a significant commitment of financial and human resources on the part of firms, but is viewed as critical to the long-term sustainability of improvements in risk management.

This is an utterly predictable regulatory response. Sure, some firms have IT gaps that prevent them from properly measuring and mitigating risk. But that’s a symptom of the underlying problem, not the problem itself. Until senior management and boards focus on risk management, IT departments and corporate treasury won’t worry about installing better IT controls.

So why does the SSG report address IT spending (in fairness, it also addresses board and management failings)? Regulators tend to struggle when it comes to getting management and boards to listen, and sometimes the company even has a well-crafted risk management policy that nobody follows–Enron being one example. It’s quick and easy for regulators to demand more technology and hope the latest software catches the next problem.

Welcome to the 21st century; welcome to carbon risk.

The recent introduction of a cap-and-trade system will probably make managing your firm’s energy strategy far more complicated and dynamic. The ability to manage carbon risk could have a direct material impact on the financial performance of a company, writes Brian Kalish, Director, Finance Practice Lead for AFP, in the latest issue of AFP’s Risk. (more…)

Two AFP members also testified before the House Financial Services Committee during Wednesday’s derivatives hearing.

Dave Hall, COO for Chatham Financial Corp., the largest independent advisor and service provider to businesses who use derivatives, testified that any derivatives legislation should be directed at trading activity between systemically significant institutions. Hall offered five recommendations:

• Margin. “Any requirement for business end users to cash collateralize hedging transactions would create an extraordinary and unnecessary drain on working capital,” Hall said. “We believe this draft should also recognize this cash burden by excluding end users from any margin requirement. For trades with business end users, we believe credit terms (e.g., margin, collateral) should be negotiated by the two parties.”

• Capital Charges. Regulators should be instructed to set capital charges “based on historic or predicted loss, and not as a penalty to discourage the use of OTC derivatives,” he said.

• Systemic Significance. The draft legislation currently could make non-systemically significant firms subject to the same regulatory burden that applies to large financial institutions. “Removing the burden for smaller, non-systemically significant swap dealers will encourage competition and reduce prices for business end users,” he said.

• Major Swap Participant. “We believe this term should be defined by legislation,” Hall said. “If it is not, we would like to see the intent be clear that this definition should target systemically significant institutions.”

• Exemptive Relief. Regulators should have the authority to provide “exemptive relief” where they deem necessary, Hall added.

Steven Holmes, Director of Treasury Operations for Deere & Company, raised three concerns. “First, we are concerned that regulators will be ceded too much authority to determine what companies are subject to higher regulatory thresholds associated with being a major swap participant and higher margin requirements imposed on end-user companies,” he said. “Second, we are concerned about the capital requirements for non-centrally cleared transactions with end-users. We believe that capital charges should be levied solely based on risk of loss and not as a means of forcing companies to centrally clear transactions.”

Holmes added that the draft’s definition of “substantial net position” creates a high degree of uncertainty and gives regulators too much authority to determine which end-users are covered.

AFP is soliciting volunteers to provide guidance and input for comment letters to federal agencies and Congressional Committees on OTC derivatives. If you are interested, please contact Jeanine Arnett, Government Relations Manager at 301-961-8853 or jarnett@afponline.org.

House Financial Services Committee Chairman Barney Frank (D-MA) ended his questions for CFTC Chairman Gary Gensler and Henry Hu of the SEC by indicating that he largely agreed with the points that they raised about the OTC derivatives reform draft. You can read their testimony here and here.

The only time Rep. Frank disagreed with Gensler and Hu was when he felt their concerns would be better addressed by the House Agriculture Committee.

Gary Gensler, chairman of the CFTC, told the House Financial Services Committee that centralized clearing is key to improving the trade of OTC derivatives. “The standardized products should be moved on to these centralized trading facilities so we have transparency,” he said. “Transparancy benefits markets.”

Henry Hu, Director, Division of Risk, Strategy, and Financial Innovation with the SEC, said swaps should be regulated like their “references” to minimize arbitrage. He also said the draft should extend SEC’s anti-fraud and anti-manipulation authority. “The draft may have inadvertently weakened that authority,” he said.

In response, Frank said that some of the points they made fell under jurisdiction of the House Agriculture Committee. “Some of the points are jurisdictional disputes between the CFTC and SEC,” he added.

More to come…