Senate Swaps Plan Overshadows Rules That Would Reshape Derivatives Market

Congressional negotiators meeting to resolve differences over bank-regulation legislation are likely to retain a proprietary-trading ban and higher capital standards while stripping a measure that would bar commercial lenders from running swaps desks, said lawmakers and analysts.

Senator Blanche Lincoln’s swaps-desk provision, which has been criticized by bankers and regulators alike, probably will be sacrificed in favor of Volcker rule trading curbs in House- Senate talks that may begin this week. Higher capital levels for larger U.S. banks may remain in the final bill as a nod to Senator Susan Collins, the Maine Republican who voted with Democrats to ensure passage of the legislation.

“The battleground will end up being the derivatives rule,” said Kevin Petrasic, a former bank regulator now with law firm Paul, Hastings, Janofsky & Walker LLP. “It will cause the Volcker rule to be locked in because folks will be willing to give on the derivatives rule if they think the Volcker rule will stay in place,” Petrasic said in a telephone interview.

The Senate last month approved legislation to answer President Barack Obama’s call for new financial-industry rules after a global economic crisis that stemmed from the collapse of the U.S. subprime mortgage market in 2008. The House approved its version in December, and negotiators from both chambers will meet this month to merge the two bills into a single measure that Obama can sign into law.

‘Separate Rule’

The proprietary trading restrictions named for former Federal Reserve Chairman Paul Volcker may eliminate the need for Lincoln’s swaps-desk plan, House Financial Services Committee Chairman Barney Frank said at a conference on May 25.

“I don’t see the need for a separate rule regarding derivatives, because the restriction on banks engaging in proprietary activity would apply to derivatives,” said Frank, the Massachusetts Democrat who will lead the House-Senate talks. Lincoln, an Arkansas Democrat who will be involved in the negotiations, said she will fight to retain her provision.

Derivatives, including swaps, are financial instruments used to hedge risks or for speculation. They’re derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

The Senate’s Volcker rule language may also be subject to debate. Democrats Jeff Merkley of Oregon and Carl Levin of Michigan, who unsuccessfully offered an amendment to strengthen the measure during the Senate deliberations, said they will continue to push for changes. Levin and Merkley have said the Senate bill should ban proprietary trading instead of leaving it to regulators to impose the ban, saying it would give them too much discretion to weaken it later.

Tier 1 Capital

A main sticking point in the Collins amendment, which would require banks with more than $250 billion in assets to meet capital standards at least as strict as those for smaller lenders, is language that would exclude trust preferred securities from being considered so-called Tier 1 capital.

Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. hold 11 percent to 15 percent of Tier 1 capital -- a gauge of a bank’s ability to withstand losses -- in trust preferred securities, Moody’s Investors Service said in May 24 report. Their exclusion “would clearly erode bank holders’ regulatory capital cushions,” the report said.

“The Collins amendment will be modified, not removed,” said Bert Ely, a banking consultant in Alexandria, Virginia.

Existing trust preferreds could be grandfathered, a move sought by the banking industry, Ely said. Lawmakers may also scale back the measure by limiting new issuances of trust preferred securities to smaller banks or restricting the amount of the securities that can count as Tier 1 capital, he said.

Interchange

Another battle looms over Senate language that would let the Fed impose limits on debit-card interchange, or “swipe,” fees that merchants pay to accept the cards. The Senate voted 64-33 to approve the amendment, offered by Senate Majority Whip Richard Durbin, an Illinois Democrat.

“This amendment, which passed the Senate with 64 votes, will enable small businesses and merchants to lower their costs and provide discounts for their customers,” Durbin wrote in a May 25 letter to Frank and Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat.

The margin of Senate support ensures “a version of it will have to be in the bill,” Frank said in an interview. The House legislation didn’t address the interchange issue.

Lawmakers must also decide whether auto dealers should be exempt from oversight by a new consumer financial-protection agency, as would be the case under the House bill. Dodd has said he opposes the exemption.

“This is going to be an interesting fight,” said John Douglas, head of the bank regulatory practice at law firm Davis Polk & Wardwell in New York. “It’s hard to say at least with respect to some portions of that industry why they shouldn’t be covered the same way other consumer lenders are covered.”

To contact the reporter on this story: Alison Vekshin in Washington at avekshin@bloomberg.net.

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