Washington, D.C Washington, D.C Washington, D.C Washington, D.C

Transcription

1 321 North Clark Street Chicago, IL (312) Fax: (312) ASSOCIATION YEAR CHAIR Nathaniel L. Doliner 4221 West Boy Scout Boulevard Suite 1000 Tampa, FL CHAIR-ELECT Lynne B. Barr Exchange Place 53 State Street Boston, MA VICE-CHAIR Linda J. Rusch P.O. Box North Cincinnati Street Spokane, WA SECRETARY Martin E. Lybecker 1875 Pennsylvania Avenue NW Washington, DC BUDGET OFFICER Renie Yoshida Grohl 8300 Fox Hound Run NE Warren, OH CONTENT OFFICER Scott E. Ludwig Suite Clinton Avenue W Huntsville, AL IMMEDIATE PAST CHAIR Karl J. Ege Suite Third Avenue Seattle, WA SECTION DELEGATES TO THE ABA HOUSE OF DELEGATES Mary Beth Clary Naples, FL Barbara Mendel Mayden Nashville, TN Maury B. Poscover St. Louis, MO Hon. Elizabeth S. Stong Brooklyn, NY COUNCIL William H. Clark, Jr. Philadelphia, PA Donald W. Glazer Newton, MA Stephanie A. Heller New York, NY Dixie L. Johnson Washington, DC William B. Rosenberg Montreal, QC Mitchell L. Bach Philadelphia, PA Conrad G. Goodkind Milwaukee, WI Paul (Chip) L. Lion III Palo Alto, CA Timothy M. Lupinacci Birmingham, AL Jacqueline Parker San Jose, CA Margaret M. Foran Naperville, IL Lawrence A. Hamermesh Wilmington, DE Myles V. Lynk Tempe, AZ Christopher J, Rockers Kansas City, MO Jolene A. Yee Modesto, CA Doneene Keemer Damon Wilmington, DE Jean K. FitzSimon Philadelphia, PA Lawrence A. Goldman Newark, NJ Joel I. Greenberg New York, NY Donald C. Lampe Greensboro, NC BOARD OF GOVERNORS LIAISON Stephen L. Tober Portsmouth, NH SECTION DIRECTOR Susan Daly Chicago, IL (312) suedaly@staff.abanet.org Chairman Ranking Member Committee on Banking, Housing, Committee on Banking, Housing, and Urban Affairs and Urban Affairs United States Senate United States Senate Washington, D.C Washington, D.C Chairman Ranking Member Committee on Financial Services Committee on Financial Services U.S. House of Representatives U.S. House of Representatives Washington, D.C Washington, D.C Re: Issues Regarding Retroactive Application of Certain Provisions Pertaining to Swaps in the Pending Derivatives Regulatory Reform Legislation (H.R. 4173) Gentlemen: As the Conference Committee considers and works to reconcile the differences in the House and Senate approved versions of H.R. 4173, I write to express our concerns with respect to the potential retroactive application to existing swap transactions of certain new requirements that would be created by the legislation. The views expressed in this letter are presented by the American Bar Association Section of Business Law (the Section ) on behalf of its Derivatives and Futures Law Committee (the Committee ). These views have not been approved by the House of Delegates or Board of Governors of the American Bar Association (the ABA ) and, therefore, should not be construed as representing the policy of the ABA. We are concerned that the potential retroactive application of the new margin provisions would result in unjust economic and other adverse consequences for parties, including commercial hedgers, that did not and could not anticipate such requirements when they entered into their contracts, raising a host of thorny legal issues, and, as a result, could lead to unnecessary protracted litigation and disruption of financial markets with uncertain outcomes. Such consequences would impede, rather than enhance, the efforts of regulators and market participants to implement the new regulatory regime for derivatives mandated by this important legislation. The Committee is comprised of lawyers who work extensively in the area of derivatives law, including private practitioners, members of the law departments of businesses, government and self-regulatory organizations, and law professors. Its membership draws from all constituencies of the derivatives industry, including, among others, commercial end users, clearinghouses and

2 Page 2 exchanges, banks and other financial organizations, commodity trading advisors, investment advisers, futures commission merchants, broker-dealers, hedge funds, and energy-industry and other companies involved with the purchase, sale and processing of many commodities. The Committee s work concerns the legal and policy issues relating to derivatives, including exchange-traded futures and options contracts and over-the-counter ( OTC ) transactions. The Committee focuses on the regulation of these markets and their participants (e.g., exchanges, clearing organizations, swap dealers, commercial market users, speculators, intermediaries, and investment managers) by the Commodity Futures Trading Commission ( CFTC ), the Securities and Exchange Commission ( SEC ), federal energy and banking regulators, international regulators, self-regulatory organizations, and state authorities. 1 The potential retroactive application to pre-existing swap transactions of any new margin requirements that the legislation authorizes the CFTC, SEC and federal banking regulators, as applicable, to impose for uncleared swaps may be quite harmful to the derivatives markets. Sections 724, 731, 763 and 764 of the Senate bill and Sections 3107, 3112, 3122, 3203 and 3204 of the House bill provide this new margining authority. 2 There are hundreds of thousands of existing swaps with periods of performance that extend beyond the likely effective date of the proposed new legislation. According to the most recent margin survey conducted by the International Swaps and Derivatives Association, Inc. ( ISDA ), the estimated number of collateralized agreements grew to 171,879 by the end of 2009 and account for an estimated $3.2 trillion in collateral used to mitigate credit risk in the OTC derivatives market. 3 Most new OTC derivative agreements provide for the posting of collateral. Consistent with current law, however, the parties to a great number of existing swaps, for valid commercial reasons, have agreed to price and other terms without imposing margin requirements 1 Although this letter was prepared under the direction of the Committee s Chair, Charles R. Mills, with contributions from a number of other Committee members, Susan C. Ervin, a Vice Chair of the Committee, abstained from preparation and review of this letter due to her position with the SEC. 2 Restoring American Financial Stability Act of 2010, H.R. 4173, 111th Cong. Sections 724, 731, 763 and 764, at , , , , , , and (as passed the Senate, May 20, 2010) ( Senate bill ); Wall Street Reform and Consumer Protection Act of 2009, H.R. 4173, 111th Cong. Sections 3107, 3112, 3122, 3203 and 3204, at , , , and (as passed the House, Dec. 11, 2009) ( House bill ). Concern with respect to retroactive application to existing transactions could apply to a number of other provisions in the Senate and House passed versions of H.R. 4173, including: (i) new fiduciary obligations of swap dealers to certain counterparties (Senate bill, Section 731, at 648 and Section 764, at ); (ii) disclosure requirements under new business conduct rules (Senate bill, Section 731, at and Section 764, at ; House bill, Section 3107, at and Section 3204, at ); and (iii) requirements that swap dealers segregate initial margin upon the request of end user counterparties (Senate bill, Section 724, at and Section 763, at ; House bill, Section 3122, at and Section 3203, at ). 3 See ISDA Margin Survey 2010, Preliminary Results April 22, 2010, which is available on the ISDA Website:

3 Page 3 or the posting of assets as collateral. 4 Many other swaps already provide for collateral, but may not satisfy the new margin requirements to be established by the regulators. Such collateral provisions are material to the economics of existing swaps and thus to the willingness and ability of parties to have entered into them. The potential retroactive imposition of margin requirements and posting of margin would unfairly subject swap counterparties to financial obligations that they did not agree to when entering into the swap contracts and possible protracted litigation involving the enforceability of retroactively applied margin requirements. Thus, the legislation potentially creates a disconnect between the economic pricing and the legal terms of a swap with no corresponding economic adjustment between the parties. Retroactive application of new economic requirements invites turmoil in swap markets and possibly related commodity and securities markets. For example, parties that cannot meet newly imposed margin requirements, or are so adversely impacted by them that continued performance under the contracts is commercially unreasonable, may stop performance on them, or bring legal actions seeking judicial declaratory judgments of contractual rights. This could impact other transactions as well, including securities and commodity futures transactions, because many swaps hedge the financial risks associated with such transactions. Securities issuers, investors, and commodity futures traders that hold significant swap positions could be forced to redeploy capital to try to minimize financial harm. Perhaps most importantly, the potential retroactive application of these requirements would inject uncertainty into the financial markets as banks, other institutions and end-users are confronted with the possibility that their swap counterparties will not perform their obligations due to materially altered economic terms. For these reasons, we agree with the testimony of Treasury Secretary Timothy Geithner before the Senate Committee on Agriculture, Nutrition, and Forestry favoring only prospective application of the new economic requirements for swaps. In response to a question regarding the Administration s view on how the various OTC derivatives reforms should affect existing contracts, Secretary Geithner testified: A critically important issue, and as I said in my opening statement, the law needs to be crystal clear that it leaves in place existing contracts, does not 4 With respect to these agreements, the parties either may have concluded that collateral was not necessary to address their counterparty credit risk or they negotiated other terms to address that risk (e.g., early termination provisions, exposure caps and resets, set-off rights, or other risk-reducing provisions).

4 Page 4 change their legal nature, does not add to uncertainty about the legal nature of those claims. 5 The Supreme Court has ruled that statutes generally should not be read to apply retroactively absent clear Congressional intent to the contrary. 6 The Court thus has explained that the purpose of requiring clear intent is to [help] ensure that Congress itself has determined that the benefits of retroactivity outweigh the potential for disruption or unfairness. 7 This rule of statutory construction, however, is potentially compromised here by the current ambiguity in the bills. There is a reasonable basis to conclude the proposed legislation would not apply retroactively to existing swaps, but the fact that the current legislation expressly prohibits retroactive application for some provisions (Senate bill, Sections 723 and 739; House bill, Section 3103) but is silent as to others creates ambiguity. 8 5 OTC Derivatives Reform and Addressing Systemic Risk: Hearing Before the S. Comm. on Agric., Nutrition & Forestry, 111th Cong (Dec. 2, 2009) (testimony of Timothy F. Geithner, Secretary, United States Treasury). Secretary Geithner did propose that parties to existing swaps be required to report them to a trade repository and maintain records consistent with the reporting and recordkeeping requirements of the proposed new legislation. Id. Such reporting and recordkeeping requirements are not part of the terms of swap transactions and should not have a material effect on the economic positions of the parties to a swap and, therefore, are not expected to be disruptive to the OTC derivatives markets. Therefore, we express no opinion on that proposal. 6 See Landgraf v. USI Film Prods., 511 U.S. 244, 270 (1994) ( Since the early days of this Court, we have declined to give retroactive effect to statutes burdening private rights unless Congress had made clear its intent. ). Congressional enactments and administrative rules will not be construed to have retroactive effect unless their language requires this result. Bowen v. Georgetown Univ. Hosp., 488 U.S. 204, 208 (1988). The power to require readjustments for the past is drastic. It ought not to be extended so as to permit unreasonably harsh action without very plain words. Brimstone R. Co. v. United States, 276 U.S. 104, 122 (1928). By the same principle, a statutory grant of legislative rulemaking authority will not, as a general matter, be understood to encompass the power to promulgate retroactive rules unless that power is conveyed by Congress in express terms. Bowen, 488 U.S. at Landgraf, 511 U.S. at Senate bill, Section 723, at 569 and Section 739, at 697; House bill, Section 3103, at 603. There also is concern that the proposed amendment to Section 22(a) of the Commodity Exchange Act, a new subsection 22(a)(5)(B) contained in Section 739 of the Senate bill, is ambiguous with respect to its impact on existing swap termination provisions. Senate bill, Section 739, at 697. The history of the Senate bill also could cloud interpretation of Congressional intent. Throughout the legislative process, it had been made clear that the new derivatives clearing requirements would not apply to transactions entered into prior to the date of enactment, while at the same time there generally has been silence regarding whether other provisions in the legislation would only be applied prospectively. During the course of deliberations on the derivatives portion of the bill by the Senate Agriculture Committee, the bill was modified to expressly provide that the new margin requirements would not be applied retroactively to existing swaps. See Damian Paletta & Scott Patterson, Deal Near on Derivatives Berkshire Presses Lawmakers to Roll Back Proposed Curbs,

5 Page 5 The Committee accordingly is concerned that, in the absence of a provision that expressly precludes the retroactive application of the legislation to existing swap agreements, the potential that a court might find that the new margin requirements for uncleared swaps do apply to existing swaps could lead to significant and undesirable disputes and litigation over retroactivity discussed above. 9 The seminal principle underlying the OTC derivatives markets has always been legal certainty for the enforcement of contractual agreements. 10 In order to avoid perceived legal uncertainty and potential systemic risk to derivatives and other markets and to facilitate the implementation of the far-reaching reforms mandated by this important legislation, we recommend that Congress make explicit its intent that the margin and other non-reporting provisions creating new requirements and obligations with respect to uncleared swaps will not apply to swap transactions entered into prior to the date of enactment. We respectfully submit that any ambiguity with respect to the issue of retroactivity of margin requirements for swaps could be remedied by inserting the words any margin, collateral or before mandatory clearing in Section 739 of the Senate bill, as follows: (5) LEGAL CERTAINTY FOR LONG-TERM SWAPS ENTERED INTO BEFORE THE DATE OF ENACTMENT OF Avoiding Potential Hit, Wall St. J., Apr. 26, This change, however, was removed from the bill prior to the vote of the full Senate. 9 A failure to address the retroactivity issue prior to enactment may result in a widespread effort by market participants to amend their contracts prior to the effective date in order to comply with the language of Section 739 and thus ensure that they will have enforceable termination rights. Such efforts would consume significant time and resources that we believe could be more productively devoted to implementation of the new provisions on a prospective basis. 10 As the Report of the President s Working Group on Financial Markets on Over-the-Counter Derivatives Markets and the Commodity Exchange Act concluded: Legal certainty is a crucial consideration when parties to OTC derivative contracts decide with whom and where to conduct their business. Parties must be certain that the contracts into which they enter are permissible in the governing jurisdiction, that their counterparties have the legal capacity to enter into the contracts, and that the provisions of the contracts are enforceable. An environment of legal certainty for OTC derivatives and their execution and clearing will help to reduce systemic risk in the U.S. financial markets and enhance the competitiveness of the U.S. financial sector. Over-the-Counter Derivatives Markets and the Commodity Exchange Act: Report of the President s Working Group on Financial Markets, at 6 (Nov. 1999).

6 Page 6 THE WALL STREET TRANSPARENCY AND ACCOUNTABILITY ACT OF (A) IN GENERAL. Any swap entered into before the date of enactment of the Wall Street Transparency and Accountability Act of 2010, the terms of which have not expired as of the date of enactment, shall not be subject to any margin, collateral or the mandatory clearing requirements under this Act. (emphasis added) We recommend adding a similar provision to the amendments to the Securities Exchange Act. We also believe including a generic statement of intent with respect to amendments to both the CEA and Exchange Act would help eliminate any legal uncertainty. In this regard, we suggest the following: The provisions of this Act shall not be applied retroactively to alter the terms of swap and security-based swap transactions entered into prior to the date of enactment. On behalf of the Section, thank you for considering our views on this important issue. If you have any questions, please contact Charles Mills, the Chair of the Committee, at Very truly yours, Nathaniel Doliner Chair, ABA Section of Business Law cc: Members of the Conference Committee on H.R The Honorable Timothy F. Geithner, Secretary of the Treasury Gary S. Gensler, Chairman, Commodity Futures Trading Commission Mary L. Schapiro, Chairman, Securities and Exchange Commission Charles R. Mills, Chair, Derivatives and Futures Law Committee, ABA Business Law Section Susan Daly, Director, ABA Business Law Section Alpha Brady, Director, ABA Policy Administration Thomas M. Susman, Director, ABA Governmental Affairs Office