Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corp. (FDIC), is fighting congressional efforts that have made progress in freeing large banks from having to hold collateral against derivatives used internally.
Hoenig has cautioned lawmakers in meetings and in a letter last week about the risks of giving the firms a pass from posting collateral in trades with their own affiliates. In the July 16 letter addressed to members of the House and Senate on the banking, appropriations, and agricultural committees, he said requiring this kind of collateral could have shielded JPMorgan Chase & Co.’s main bank from the London Whale trading losses that totaled more than US$6 billion.
“Without margin exchanged for these trades, affiliates often enter into uncleared swaps transactions with the banks,” Hoenig wrote. “These affiliates can often operate with less capital and liquidity reserves than the market would otherwise require, as market participants treat these affiliates as if they were an extension of the bank.”
Earlier this month, House appropriators passed an amendment that would urge the Commodity Futures Trading Commission (CFTC), one of several agencies trying to write rules governing collateral for trading uncleared swaps, to recognize that such internal risk management transactions benefit customers. Last week, top Republican and Democratic lawmakers on a House panel that oversees the CFTC sent a letter to regulators asking them to reconsider the demand for collateral.
Clients of Wall Street firms could face higher costs as a result of last year’s proposed rule calling for lenders to post margin when trading swaps with their own affiliates, Representatives K. Michael Conaway and Collin Peterson wrote in a July 17 letter to six regulators including CFTC Chairman Timothy Massad.
“Internal risk management transactions are necessary for global financial institutions to manage their risk profile and enable banks to provide cost-effective services to their clients,” said Conaway, the Texas Republican who leads the House Agriculture Committee, and Peterson of Minnesota, the top Democrat on the panel. The current proposal—which isn’t yet a final rule—could harm markets without reducing risk, the lawmakers said.
The rulemaking effort, which has dragged on for years, could lead to firms including JPMorgan and Morgan Stanley having to set aside tens of billions of dollars in collateral. Bank lobbyists have pushed some regulators to second-guess how strict they should be, and the agencies have been mired in disagreements, Bloomberg reported last month.
JPMorgan was fined more than $1 billion by U.S. and U.K. regulators in 2013 for management failings after Bruno Iksil, known as the London Whale because of his large bets, incurred $6.2 billion in losses in 2012. The scandal erased as much as $51 billion of shareholder value and led to the departure of four senior managers, including Chief Investment Officer Ina Drew.
Financial companies have argued they shouldn’t be forced to put up collateral in swaps transactions with their own divisions. The firms typically do these trades to transfer risk from their affiliates to their deposit-taking banks, where they enjoy better borrowing rates. Current practice doesn’t include the same collateral demand.