(Bloomberg) — A quarrel among regulators could add up to billions in savings for Wall Street banks.
At stake is a proposed rule that has dragged on for years that could require firms like JPMorgan Chase & Co. and Morgan Stanley to set aside tens of billions of dollars in collateral when trading swaps with their own affiliates. Now, a last-ditch effort by bank lobbyists has helped spur some regulators to second-guess how strict they should be, according to three people familiar with the discussions.
The Office of the Comptroller of the Currency, which regulates some of the largest banks that deal in swaps, is leaning toward insisting only an affiliate post collateral to the bank, said the people, who requested anonymity because the final rule isn't yet public. The Federal Deposit Insurance Corp. has backed a version of the rule proposed in September, demanding both a bank and its affiliate put up collateral, the people said.
Swaps trading — when it was largely unregulated — amplified the financial crisis seven years ago. An aggressive collateral rule would help prevent affiliates from collapsing and leaving taxpayers on the hook, Thomas Hoenig, vice chairman of the FDIC, said in an interview. Banks also are hiding behind the complexity of the rule to say it puts them at a competitive disadvantage with foreign rivals, he said.
"It's never a competitive disadvantage to operate in a more stable and robust financial system, as the banks that entered the financial crisis with the lowest capital levels quickly discovered," Hoenig said.
Transfer Risk
Financial firms have argued they shouldn't be required to put up collateral in swaps transactions with their own divisions, which they say they do to hedge risks. For example, under the version of the rule the FDIC has advocated for, JPMorgan would be required to post collateral against a trade of non-cleared swaps with its U.K. brokerage, and the U.K. brokerage would have to post collateral to JPMorgan as well. Andrew Gray, a JPMorgan spokesman, declined to comment.
The firms typically do these trades to transfer risk from their affiliates to their deposit-backed banks, where they enjoy better borrowing rates. Current practice doesn't call for collateral in these transactions.
The FDIC's Hoenig said trades with overseas units can expose banks to serious risks. If an affiliate implodes and drags down the U.S. holding company, the FDIC would have to prop up the mess — keeping depositors' money safe and using Dodd- Frank Act powers to rebuild a healthy version of the parent company. If banks are required to post collateral to their units, it reduces the likelihood that the FDIC would have to intervene in a crisis, he said.
The biggest swaps dealers include JPMorgan, Morgan Stanley, Goldman Sachs Group Inc., Citigroup Inc. and Bank of America Corp. It's difficult to estimate how much money is at stake for them given the complexity of the market. If the final rule is less stringent than the September proposal, they could reduce the collateral they have to hold by tens of billions. That's a slice of about $644 billion in collateral that would be held by banks in non-cleared swap trades, according to preliminary OCC estimates.
Forcing the banks to hold extra collateral would hurt liquidity, said Adam Gilbert, a former JPMorgan executive who now advises on financial regulation at PricewaterhouseCoopers LLP. Firms may find it so costly they decide not to do the internal transactions at all, he said.
