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Goldman Says Rule Curbing Counterparty Links Risks Jobs

Flags fly outside of Goldman Sachs Group Inc. headquarters in New York. Photographer: Jin Lee/Bloomberg
Flags fly outside of Goldman Sachs Group Inc. headquarters in New York. Photographer: Jin Lee/Bloomberg

May 2 (Bloomberg) -- Goldman Sachs Group Inc. said a proposed Federal Reserve rule seeking to limit links between banks could cut U.S. economic growth by as much as 0.4 percentage point and eliminate as many as 300,000 jobs.

The estimate, the most specific so far in reaction to the Fed’s proposed rule, was based on New York-based Goldman Sachs’s own research and assessment of how it would affect the corporate debt market, according to an April 30 letter to the Fed that was made public yesterday.

“The impact on the corporate bond market alone could drive the elimination of 150,000 to 300,000 American jobs,” wrote Goldman Sachs Chief Risk Officer Craig W. Broderick. “Smaller companies that lack access to alternative sources of capital -- and that drive job creation -- would be hardest hit.”

The bank joined rivals including JPMorgan Chase & Co., Citigroup Inc. and Morgan Stanley in opposing a rule that would limit financial firms with at least $500 billion in assets from having credit risk to any other exceeding 10 percent of its regulatory capital plus excess loan-loss reserves. That limit is stricter than a 25 percent limit that’s applied more broadly to banks in the Dodd-Frank financial-overhaul law.

Goldman Sachs, the fifth-biggest U.S. bank by assets, had $77.1 billion in total regulatory capital and no loan-loss reserves as of Dec. 31, according to the firm’s annual filing.

Chief executive officers of the largest U.S. banks, including New York-based JPMorgan, are set to meet with Fed Governor Daniel Tarullo today to discuss the proposed rule as well as the Fed’s recent stress tests of banks, four people familiar with the meeting said earlier this week.

Derivatives Market Impact

One concern for the banks is how the limits would affect the market for derivatives. As of December, five firms accounted for 96 percent of the total U.S. banking industry’s notional holdings in derivatives and 86 percent of the industry’s net current credit exposure in derivatives, according to the Office of the Comptroller of the Currency.

The proposed limits “greatly overstate credit exposures, particularly with respect to counterparty exposure arising from derivatives,” Citigroup Chief Risk Officer Brian Leach said in a letter to the Fed. “The overstatement of the credit exposure will require financial institutions to substantially reduce lending to customers, reduce market-making activities in derivative instruments on behalf of customers, and either purchase less credit protection, or purchase credit protection from smaller, less well-capitalized institutions or from ‘shadow banking’ firms.”

‘Technical Flaws’

The Fed’s method of measuring counterparty credit doesn’t consider that some contracts offset each other and that trading partners receive collateral to mitigate potential risks, according to Goldman Sachs’s letter. These issues, along with other “technical flaws” in the proposed rule’s approach, would lead counterparty exposures to be overestimated by as much as four to 18 times the actual risk, the company wrote.

A firm also may be hindered in lending to small businesses if its attempt to buy protection from other banks pushes it over the exposure limits, according to Goldman Sachs.

The Fed should “conduct a full quantitative impact study on the overstatement of exposure and interconnectedness” under the so-called single counterparty credit limit “and the implications of that overstatement for U.S. financial markets and U.S. economic activity,” according to the letter.

Business Roundtable

Groups including the U.S. Chamber of Commerce and the Business Roundtable have successfully challenged the legality of other regulatory measures by claiming authorities didn’t fully assess the costs.

In July, the U.S. Court of Appeals in Washington overturned a Securities and Exchange Commission rule that would have expanded shareholder rights. That has made future SEC rules vulnerable to similar challenges, forcing agency Chairman Mary Schapiro to redouble efforts to study cost-benefit effects, slowing the rulemaking process.

Michael Bleier, a former Fed lawyer and now a partner at Reed Smith LLP, said the banks’ comments will sway regulators and that the central bank may “have to rethink” its analysis.

“The Fed will ultimately have to raise that 10 percent limit,” Bleier said. “That should be accompanied by some type of economic analysis to determine what the right number is.”

The limits also could reduce banks’ use of clearinghouses to trade derivatives and damage sovereign-debt markets because banks would be limited in how much credit they could extend to foreign governments, according to the letter.

Aggregation Requirement

“The proposed rules’ aggregation requirement also creates difficulties by casting the net too broadly,” Goldman Sachs wrote. “It requires covered companies to aggregate all ‘controlled’ subsidiaries, defined as 25 percent or more of the voting shares or equity, which will be difficult for covered companies to do in practice.”

Morgan Stanley, the sixth-biggest U.S. bank by assets, said the Fed’s definition of what constitutes “controlling” a subsidiary would force it to include the exposures held by a Japanese joint venture that Mitsubishi UFJ Financial Group Inc. operates. Including those risks would “constrain its ability to enter into credit transactions with counterparties whose obligations are also held by the joint venture,” Morgan Stanley Chief Risk Officer Keishi Hotsuki wrote in a letter to the Fed.

Goldman Sachs, in a list of recommendations to the central bank, said the 25 percent limit on single counterparty credit should be applied to all companies “regardless of asset size” and that clearinghouses and “high-quality sovereigns” be excluded from the limits. Subsidiaries also should be excluded unless they’re consolidated for financial-reporting purposes, according to the letter.

The firm called on the Fed to let companies wait until July 2015 to conform to the rules and spend an additional five years to implement monitoring of the limits.

“This additional time would allow covered companies to carefully reduce their excess exposures,” Goldman Sachs wrote. “Allowing time for this to occur would reduce the risk of ‘fire sales’ or serious market disruptions.”

To contact the reporter on this story: Christine Harper in New York at

To contact the editor responsible for this story: David Scheer at

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