A rule proposed by the Board of Governors of the Federal Reserve, Federal Deposit Insurance Corporation, and Office of Comptroller of the Currency will have serious consequences for the ability of public power utilities and rural cooperatives to find regulated counterparties for the forward contracts, commodity trade options, and energy commodity swaps needed to hedge price and supply risks, the American Public Power Association and the National Rural Electric Cooperative Association said in Jan. 3 comments.
At issue is a Notice of Proposed Rulemaking on Regulatory Capital Rule: Large Banking Organizations and Banking Organizations with Significant Trading Activity issued by the Board of Governors of the Federal Reserve, Federal Deposit Insurance Corporation, and Office of Comptroller of the Currency.
The proposed rule was drafted to comply with “Basel III” -- an internationally agreed set of measures developed by the Basel Committee on Banking Supervision in response to the financial crisis of 2007-09.
Basel III measures aim to strengthen the regulation, supervision, and risk management of banks.
The Proposed Rule would increase capital requirements for certain transactions, including hedging transactions with non-registered entities, including public power utilities and rural electric cooperatives.
APPA and NRECA have members that utilize commodity markets and rely on bilateral physical power and natural gas contracts, and enter energy commodity swaps, options, and futures contracts to hedge commodity supply and price risks.
The members enter these commodity instruments as commercial “end users” seeking to hedge supply risks and minimize price variability, not for purposes of speculation.
Under the proposed rule, for an entity entering such transactions with a large bank to receive a favorable risk weight, the entity must be: (1) investment grade; and (2) publicly traded or the parent entity that controls a company that is publicly traded.
Rule makers argued that this would provide “a simple, objective criterion that would provide a degree of consistency across banking organizations.” In addition, the proposal states that “publicly traded corporate entities are subject to enhanced transparency and market discipline as a result of being listed publicly on an exchange.”
APPA and NRECA said that they are concerned that the proposed rule “will make effective risk management more difficult and more expensive for commercial end-users in the energy industry, including our members, without materially improving risk management for the banking sector.”
The groups believe “that the proposed rule as drafted will have serious consequences for our members’ ability to find regulated counterparties for the forward contracts, commodity trade options, and energy commodity swaps needed to hedge price and supply risks.”
Specifically, because members of APPA and NRECA are not publicly traded, large bank counterparties would face increased capital requirements for such transactions – “transactions that we believe do not create more risk to large banks, simply because the bank’s counterparty happens to be a cooperative or a government-owned entity.”
In turn, large banks will be less willing to participate in such transactions or, at a minimum, increase the charges for participating in such transactions to cover the additional costs imposed by the more stringent capital requirements, APPA and NRECA said.
“Specifically, we believe the proposed rule’s two-pronged approach to receive a lower 65 percent risk weight for derivatives transactions is flawed and should be removed or reworked substantially. The criteria for publicly traded companies included it the proposed rule is a far more restrictive capital requirement than that of the EU and UK capital frameworks, and places American banks – and their customers – at a material competitive disadvantage. We believe this provision should be removed or revised significantly,” APPA and NRECA said.
In addition, the proposal states that “publicly traded corporate entities are subject to enhanced transparency and market discipline as a result of being listed publicly on an exchange.”
APPA and NRECA said that this too is a flawed argument. They noted that their members are community-owned and governed by democratically elected officials “who are required to operate transparently and in the public’s best interest and must abide by laws and regulations instituted by multiple layers of government.”
The groups called into question “the suggestion that, as non-publicly traded entities, co-ops, and government-owned entities are fundamentally more of a credit risk due to their ownership structure.”
Because co-ops are consumer-owned and operate at cost, it is in the best interests of the co-op to fulfill its financial obligations in the most cost-efficient, risk-averse manner possible. Public power providers operate in a similar vein and are accountable to the communities they serve, APPA and NRECA said.
“There is a reason why more than half of all public power utilities have been in operation for a century or longer -- and more than three-quarters have been in operation since World War II. On the other hand, publicly traded companies operate to maximize shareholder return and it can be argued that this type of ownership structure is vulnerable to the short-term interests of shareholders and shareholder returns at the expense of the firm’s long-term financial viability and operation.”
If the proposal’s “bias against non-public traded companies, cooperatives, and government-owned entities is left intact, we believe it will severely and needlessly disrupt the ability of our Joint Association members to participate in risk management hedging transactions with large banks,” APPA and NRECA said.
“Adopting precedents in federal law that cooperatives, government-owned entities, and other non-publicly traded companies are less creditworthy and more risky than publicly traded companies is also dangerous and unwarranted.”
The groups said that the proposed rule should be revised “so that our members can continue to manage commodity risks by using hedging instruments without undue cost or complexity.”
If the proposed rule is adopted as drafted, “we fear that there will be a decrease in hedging, increased costs to our consumer members, and increased market volatility in the energy sector, which is already facing many uncontrolled externalities.”