On December 16, 2014, President Obama signed into law an appropriations act that included an amendment to Section 716 (the Swaps Pushout) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). This amendment was based on H.R. 992, the Swaps Regulatory Improvement Act, which passed the U.S. House of Representatives on October 30, 2013 in a bipartisan 292-122 vote. Prior to this week’s amendment, the Swaps Pushout barred “swap entities” from receiving any federal assistance, including access to the Federal Reserve discount window and federal deposit insurance.
The practical effect of the Swaps Pushout, as originally enacted, was to prohibit banks that are swap dealers from dealing in equity swaps, credit default swaps, and commodity swaps. In order to receive federal assistance, banks were required to push out swaps to non-bank affiliates. Certain swap activity viewed as less risky, such as rates, currencies, and assets that national banks are permitted to hold, as well as swaps used to hedge or mitigate risk, could still be done by bank swap dealers.
The Swaps Pushout, as amended, significantly broadens the types of swaps and swaps activities that can remain in the bank. The Swaps Pushout is now limited only to “structured finance swaps.” Structured finance swaps are those swaps referencing asset-backed securities (ABS) or a group or an index primarily composed of ABS. In addition, structured finance swaps that are undertaken for hedging purposes or where the ABS underlying the structured finance swaps is of a credit quality and of a type or category with respect to which the prudential regulators consider acceptable, need not be pushed out to non-bank affiliates.
The amendment to the Swaps Pushout will directly affect those banks that would have had to move most of their swaps activity to non-bank affiliates, which could have resulted in increased capital and risk management costs and lower profitability. To the extent that such savings are passed along to bank dealer counterparties, the amendment to the Swaps Pushout could have an effect on the swaps market as a whole in the form of improved pricing and liquidity.