WASHINGTON — The House Financial Services Committee approved a bill 43 to 26 on Thursday designed to regulate derivatives after last minute additions that will cut into industry profits on such contracts.
The bill would direct tougher regulation toward dealers and major swaps participants. These categories would include large Wall Street banks, such as Goldman Sachs Group Inc. and JPMorgan Chase & Co., whose investment businesses contain divisions dedicated to offering companies such as manufacturers and energy firms derivatives contracts to hedge their exposures.
If the bill is enacted, dealers would have to trade their contacts over exchanges — a move that could severely cut into their profits. Jamie Dimon, the chief executive of JPMorgan Chase, warned Wednesday during the bank's third-quarter earnings conference call that mandatory exchange trading "could have a material impact on the business."
Big banks have had steady profits from derivatives in recent years in part because such contracts are confidential. But forcing them to trade contracts on an exchange would open up transparency to that market, putting more competitive pressures onto dealers.
Financial Services Committee Chairman Barney Frank added the exchange-trading requirement Wednesday, despite opposition from industry lobbyists, who had been confident that such a provision lacked necessary support. But moderate business-friendly Democrats supported the amendment during the vote Thursday, helping it to pass 39 to 25.
Another new provision in Frank's bill was added by an amendment from Rep. Stephen Lynch, D-Mass., designed to limit the ability of dealers, dealer affiliates and major swap participants to own controlling stakes in clearing platforms. The amendment passed by a voice vote Thursday morning.
Proponents of tougher derivatives regulation have said that limiting direct ownership will not necessarily keep big banks from influencing clearing platforms.
But curtailing their direct control could keep banks from establishing their own clearing houses or alternative clearing facilities in an attempt to escape harsher margin requirements that come along with clearing, or to minimize the number of derivatives contracts the platforms are willing to accept for clearing.
Industry observers said large banks will fight back hard against the exchange-trading requirement, and will look for support from Senate Banking Committee members, including Chairman Chris Dodd, D-Conn., and Sen. Charles Schumer, D-N.Y.
But the banks are unlikely to get far with the House Agriculture Committee, which is due to vote on its own derivatives bill next week. Chairman Collin Peterson, D-Minn., also supports an exchange-trading requirement for contracts that have been accepted for central clearing.
While the large banks have been fighting the derivatives bill, community banks have largely stayed out of the fray. But questions arose Thursday about whether community and regional banks could unintentionally get caught up in the clearing and exchange-trading requirements presented in Frank's bill. Though lawmakers offered repeated assurances during the markup of the bill Wednesday that smaller firms would not be subjected to onerous clearing and margin requirements, a few observers are afraid that vague language in the bill could be applied to a wider number of banks than expected.
"We are concerned that those community banks engaged in loan-level hedging could be considered dealers," said Sam Peterson, a consultant on the community bank team of Chatham Financial, a financial consulting firm in Philadelphia that advises end users on hedging strategies.
Peterson said that since community banks offer some customers interest rate swaps to help them take out fixed-rate loans instead of riskier, variable-rate ones, they could be placed in the same category as the major dealers, like Goldman and JPMorgan Chase. Under Frank's bill, Commodity Futures Trading Commission Chairman Gary Gensler could end up deciding to include community banks in the category of dealers, Peterson said.
"We're hoping that community banks will kind of express themselves on that issue," he said.