WASHINGTON — Swap dealers that pitch to, advise, or enter into swap agreements with states, localities, and public pension funds would have a “fiduciary duty” to put the interests of those entities first, under legislation released Friday afternoon by Senate Agriculture Committee chairman Blanche Lincoln.
By holding swap dealers to the same fiduciary standard of conduct as investment advisers, the Arkansas Democrat said that Wall Street firms would no longer be able to take advantage of “Main Street and taxpayers.”
The bill also would require bank holding companies to spin off derivatives-trading subsidiaries to be eligible for federal assistance, such as federal deposit insurance or the ability to borrow directly from the Federal Reserve.
Lincoln’s bill, which is tentatively scheduled to come before the committee for a vote on Wednesday morning, is more sweeping than derivatives legislation in broad financial regulatory reform approved by the House late last year and in the Senate Banking Committee last month.
Once it clears her committee, the bill is expected to be merged with or replace existing derivatives language in the Senate Banking Committee’s package, sources said. Senate Democrats are hoping to push the legislation through the chamber quickly so that it can then be conferenced with the House bill, reapproved by both chambers, and signed into law before the fall elections.
President Obama said Friday that passing financial regulatory reforms should not be delayed any longer and pledged to veto legislation that does not impose federal oversight of the currently unregulated derivatives market.
While many market participants are still studying the language in Lincoln’s 336-page bill, some noted that states and localities would be restricted from being considered eligible contract participants in OTC swap agreements unless they have $50 million in “discretionary investments.”
Transactions involving non-ECPs would have to be traded on exchanges, which would require the contracts to be standardized — an unworkable proposition for most localities.
But one attorney who had quickly reviewed the language said that Lincoln’s bill appears to mirror the House bill’s language in that the $50 million threshold would be meaningless. That is because the bill does not amend a section of the Commodity Exchange Act that essentially says any government can be considered an eligible contract participant for a derivative transaction as long as its counterparty is a bank, a broker-dealer, a broker-dealer holding company, or an insurance company. That list of firms represents all of the potential kinds of counterparties in muni market derivatives transactions.
The attorney speculated that Lincoln’s staff drafted that section poorly if its intent was to restrict small municipalities from participating in derivatives transactions.
The attorney also noted that Lincoln’s bill excludes language added to the Senate Banking Committee bill that would require an issuer to hire an independent swap adviser and for its dealer counterparty to have “a reasonable basis” to believe that the adviser has expertise and will make disclosures to the issuer about fair pricing and the appropriateness of the transaction.
Peter Shapiro, managing director at Swap Financial Group in South Orange, N.J., said that even if the bill restricted eligible contract participants to those with $50 million in discretionary investments, this would be “ill considered” and “out of touch with what constitutes a sophisticated municipality.”
“Sophistication in municipal borrowers is not determined by investable assets, it’s determined by the management of debt or management of commodity exposures,” he said. “The notion that a city treasurer who monitors $50 million in investments is sophisticated just plain misunderstands what their job consists of. That’s not what they do; they manage the debt side.”
Shapiro said that imposing a fiduciary duty on swap dealers is “a tricky concept” and that it’s “a little strange to impose that duty to the side that’s selling.”
“The swap counterparty has interests that are adverse” to a municipality, he said. “We have always emphasized that the bank is not on the same side of the table as an issuer.”
