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Attorney offers overview of swaps and the Dodd-Frank Act

From the October 28, 2013 issue of Public Power Daily

Originally published October 28, 2013

By Jeannine Anderson

SEATTLE—The story of how swaps came to be regulated under the Dodd-Frank Wall Street Reform and Consumer Protection Act is a narrative that goes back to when Alan Greenspan was head of the Federal Reserve, attorney Dan Berkovitz told an audience of public power lawyers here Oct. 20. Berkovitz, a partner with WilmerHale LLP and former general counsel to the Commodity Futures Trading Commission, spoke at a seminar prior to APPA's Legal Seminar.

Prior to the Dodd-Frank Act, the swaps market was largely unregulated, although energy trading had its own peculiar regulatory structure, he said. Swaps markets developed in the 1980s, and the Commodity Futures Trading Commission struggled with the question of whether a swap was a futures contract (and therefore unlawful to trade except on a regulated futures exchange). 

In the 1980s and 1990s, the CFTC exempted various types of swaps from regulation by the commission. Uncertainty remained, however, so in 2000, Congress passed the Commodity Futures Modernization Act, which deregulated the swaps market. That law excluded swaps from CFTC regulation under the Commodity Exchange Act. Swaps thus were bilaterally negotiated and executed over the counter, largely beyond the reach of the CFTC, Berkovitz said.

For years, he said, there had been concerns that the deregulated financial markets weren’t working. 

Then came the turbulent years at the end of the 20th century, marked by increasing speculation in commodity markets. Oil prices went up. There was the western power crisis of 2000-2001 and the Enron debacle. A few years later, in 2008, several large financial firms collapsed (Bear Stearns, Lehman Brothers, AIG), heralding the start of the Great Recession.

The Financial Crisis Inquiry Commission established by Congress concluded that the failure of regulation and supervision was partly to blame for the recession, Berkovitz said. The commission pointed to failures of corporate governance and risk management. Excessive borrowing, risky investments and lack of transparency -- including lack of regulation of over-the-counter derivatives –- all were part of the problem, the commission said. 

 "The rationale for deregulation of swaps was no longer persuasive," Berkovitz said.

He noted that Alan Greenspan, who chaired the Federal Reserve from 1987 until 2006, had been a proponent of the idea that sophisticated investors did not need governmental protection. Other prevailing beliefs at the time were that institutions dealing in over-the-counter derivatives were well regulated, and that the self-interest of market players could be counted upon to keep them from taking excessive risks.

"These arguments did not hold any more," Berkovitz said. "Greenspan testified before Congress and said, ‘Our model was wrong.’"

There was a movement toward financial reform, and this became the Dodd-Frank Act. "We drew up a 72-page draft," said Berkovitz, who was working for the CFTC at the time. Eventually, the bill grew to fill more than 300 pages. 

"The idea was to regulate the markets to reduce systemic risk," he said. Jurisdiction was split between the CFTC and the Securities and Exchange Commission. The CFTC would regulate "swaps," and the SEC would regulate "security-based swaps."

Dodd-Frank creates a comprehensive new regime for the regulation of the swaps markets, he said. Although the most significant impact is on financial institutions, the law also affects others, such as utilities that use swaps to hedge their business risks.

Now, with the CFTC regulations mostly complete, "we’re in a very interesting time," Berkovitz said. Today, "there’s a big movement toward futures rather than swaps, because people fear regulation of swaps."

Dodd-Frank gives "enormous authority, responsibility and discretion" to the CFTC and the SEC to carry out its rules, he said.

Among the many provisions:

  • All swaps subject to mandatory clearing must be cleared unless an exception or exemption exists.
  • Virtually all swaps must be reported to a swap data repository, even if not cleared or exchange-traded.
  • End users must keep full complete and systematic records of all data pertaining to swaps during the life of the swaps and for five years thereafter.

A provision designed to protect "special entities," including public power utilities, provides that counterparties entering swaps of up to $25 million per year with these utilities do not have to register as swap dealers under the Dodd-Frank Act. If they go over that amount, however, they must register as swap dealers.

APPA and others have argued that this threshold is too low. In June 2013, the House of Representatives passed a bill supported by APPA, the Public Power Risk Management Act, which would exempt a utility operations-related swap transaction with a public power utility from the $25 million special entity threshold. 



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Senior Vice President, Publishing 
Jeanne Wickline LaBella

Editorial Director
Robert Varela

Editor, Public Power Daily
Jeannine Anderson

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Fallon W. Forbush

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David L. Blaylock

Integrated Media Editor 
Laura D’Alessandro