Big Criminal Banks Get Break in Rules to Limit Risks
- By BEN PROTESS - May 15, 2013- The New York Times
Under pressure from Wall Street lobbyists, federal regulators have agreed to soften a rule intended to rein in the banking industry’s domination of a risky market.
The changes to the rule, which will be announced on Thursday, could effectively empower a few big banks to continue controlling the derivatives market, a main culprit in the financial crisis.
The $700 trillion market for derivatives — contracts that derive their value from an underlying asset like a bond or an interest rate — allow companies to either speculate in the markets or protect against risk.
It is a lucrative business that, until now, has operated in the shadows of Wall Street rather than in the light of public exchanges. Just five banks hold more than 90 percent of all derivatives contracts.
Yet allowing such a large and important market to operate as a private club came under fire in 2008. Derivatives contracts pushed the insurance giant American International Group to the brink of collapse before it was rescued by the government.
In the aftermath of the crisis, regulators initially planned to force asset managers like Vanguard and Pimco to contact at least five banks when seeking a price for a derivatives contract, a requirement intended to bolster competition among the banks. Now, according to officials briefed on the matter, the Commodity Futures Trading Commission has agreed to lower the standard to two banks.
About 15 months from now, the officials said, the standard will automatically rise to three banks. And under the trading commission’s new rule, wide swaths of derivatives trading must shift from privately negotiated deals to regulated trading platforms that resemble exchanges.
But critics worry that the banks gained enough flexibility under the plan that it hews too closely to the “precrisis status.”
“The rule is really on the edge of returning to the old, opaque way of doing business,” said Marcus Stanley, the policy director of Americans for Financial Reform, a group that supports new rules for Wall Street.
Making such decisions on regulatory standards is a product of the Dodd-Frank Act of 2010, which mandated that federal agencies write hundreds of new rules for Wall Street. Most of that effort is now complete at the trading commission. But across several other agencies, nearly two-thirds of the rules are unfinished, including some major measures like the Volcker Rule, which seeks to prevent banks from trading with their own money.
The deal over derivatives was forged from wrangling at the five-person commission, which was sharply divided. Gary Gensler, the agency’s Democratic chairman, championed the stricter proposal. But he met opposition from the Republican members on the commission, as well as Mark Wetjen, a Democratic commissioner who has sided with Wall Street on other rules.
Mr. Wetjen argued that five banks was an arbitrary requirement, according to the officials briefed on the matter. In advocating the two-bank plan, he also noted that the agency would not prevent companies from seeking additional price quotes. Other regulators have proposed weaker standards.
Mr. Gensler, eager to rein in derivatives trading but lacking an elusive third vote, accepted the deal. By his reckoning, the compromise was better than no rule at all.
In an interview on Wednesday, Mr. Gensler said that, even with the compromise, the rule will still push private derivatives trading onto regulated trading platforms, much like stock trading. He also argued that the agency plans to adopt two other rules on Thursday that will subject large swaths of trades to regulatory scrutiny.
“No longer will this be a closed, dark market,” Mr. Gensler said. “I think what we’re planning to do tomorrow fulfills the Congressional mandate and the president’s commitment.”
Yet the deal comes at an awkward time for the agency. Mr. Gensler, who was embraced by consumer advocates but scorned by some on Wall Street, is expected to leave the agency later this year now that his term has technically ended.
In preliminary talks about filling the spot, the White House is expected to consider Mr. Wetjen, a former aide to the Senate majority leader, Harry Reid. The administration, according to people briefed on the matter, is also looking at an outsider as a potential successor: Amanda Renteria, a former Goldman Sachs employee and Senate aide.
The prospect of someone other than Mr. Gensler completing the rules provided some momentum for the compromise, officials say. The officials also noted that Mr. Gensler had set a June 30 deadline for completing the plan.
The White House declined to comment. Mr. Gensler, who has not said whether he will seek a second term at the agency, declined to discuss his plans on Wednesday.
While the regulator defended the derivatives rule, consumer advocates say the agency gave up too much ground. To some, the compromise illustrated the financial industry’s continued influence in Washington.
“The banks have all these ways to reverse the rules behind the scenes,” Mr. Stanley said.
The compromise also alarmed Bart Chilton, a Democratic member of the agency who has called for greater competition in the derivatives market. Still, Mr. Chilton signaled a willingness to vote for the rule.
“At the end of the day, we need a rule and that may mean some have to hold their noses,” he said.
That grip, regulators and advocacy groups say, empowers those banks to overcharge some asset managers and companies that buy derivatives. It also raises concerns about the safety of the banks, some of which nearly toppled in 2008.
“It’s important to remember that the Wall Street oligopoly brought us the financial crisis,” said Dennis Kelleher, a former Senate aide that now runs Better Markets, an advocacy group critical of Wall Street.
With that history in mind, Congress inserted into Dodd-Frank a provision that forces derivatives trading onto regulated trading platforms. The platforms, known as swap execution facilities, were expected to open a window into the secretive world of derivatives trading. But Congress left it to Mr. Gensler’s agency to explain how they would actually work.
There was a time when Mr. Gensler envisioned the strictest rule possible. In 2010, he pushed a plan that could, in essence, make all bids for derivatives contracts public. Facing complaints, the agency instead proposed a plan that would require at least five banks to quote a price for derivatives passing through a swap execution facility.
But even that plan prompted a full-court press from Wall Street lobbyists. Banks and other groups that opposed the plan held more than 80 meetings with agency officials over the last three years, an analysis of meeting records shows. Goldman Sachs attended 19 meetings; the Securities Industry and Financial Markets Association, Wall Street’s main lobbying group, was there for 11.
The banks also benefited from some unlikely allies, including large asset managers that buy derivatives contracts. While money managers may seem like natural supporters of Mr. Gensler’s plan — and some in fact are — the industry’s largest players already receive significant discounts from select banks, providing them an incentive to oppose Mr. Gensler’s plan.
The companies cautioned that, because Mr. Gensler’s plan would involve a broader universe of banks, it could cause leaks of private trading positions. The plan, the companies said, would not necessarily benefit the asset managers.
“If someone told me I needed to shop five different places for a pair of jeans, I don’t see how that would help me,” said Gabriel D. Rosenberg, a lawyer at Davis Polk, which represents Sifma and the banks.
The banks and asset managers also warned that many derivatives contracts are traded too infrequently to even generate attention from five banks.
Some regulators dispute that point. They point to the industry’s own data, which shows that 85 percent of derivatives trading in a recent 10-day span occurred in four products that are arguably quite liquid. (Each traded more than 500 times.)
As such, according to officials briefed on the matter, Mr. Chilton proposed a plan to require quotes to be submitted to at least five banks for the most liquid contracts. Under his plan, contracts that were less liquid could still be subject to at least two.
Mr. Wetjen, who saw the effort as too complicated, continued to favor the two-bank plan. While the requirement jumps to three banks in about 15 months, the agency might also have to produce a study that could undermine that broader standard.
In an interview, Mr. Wetjen explained that he was seeking to grant more flexibility to the markets. “If flexibility means it’s more beneficial to the banks, so be it,” he said. “But it also means it’s more flexible to all market participants and the marketplace as a whole.”
Some consumer advocates have raised broader concerns about Mr. Wetjen, who once advocated a wider than expected exemption to part of a derivatives rule. They also complained that Mr. Wetjen has split with Mr. Gensler on aspects of a plan to apply Dodd-Frank to banks trading overseas. He has, however, voted with Mr. Gensler on every rule, unlike the other commissioners.
Mr. Wetjen also noted that his actions often upset the banks. On only a few issues, he happened to agree with them.
“I’m not driven by who wages the argument,” he said. “It’s about what policy makes sense.”