Wall Street banks have a special loathing for a new and arcane rule, and they have gone to extraordinary lengths — like helping write a bill that is currently in Congress — to neuter it.
But in recent weeks, the banks have started to eagerly embrace exactly the sort of changes that the hated regulation demands of them, though it is not because they have suddenly come to believe in the rule.
The regulation in question is something called the swaps push-out rule, a part of the Dodd-Frank Act, which Congress passed in 2010 to overhaul the financial system after the 2008 crisis. Banks make huge amounts of money from trading in derivatives — financial contracts that can be used to bet on things like interest rates, stock prices and the creditworthiness of corporations. Swaps are a type of derivative.
Even though derivatives trading is a quintessential Wall Street business, banks have been able to do virtually all of it in their traditional banking subsidiaries, which benefit from deposit insurance and other forms of federal support. Citigroup, for instance, had $63.5 trillion worth of derivatives on its books at the end of 2013, $62.3 trillion of which was inside its insured banking subsidiary. While these numbers overstate the amount the bank has at risk, it is worth noting as a comparison that the United States gross domestic product for the first quarter of 2014 was running at an annual rate of about $16 trillion.
Banks can make more money from derivatives trading by doing it in their insured subsidiaries. These subsidiaries usually have higher credit ratings than other parts of the bank, in part because of their implied government support. And the higher ratings enable the banks to get better terms in the derivatives bets they make with their trading partners, bolstering the banks’ profits.
Dodd-Frank’s swaps push-out rule seeks to reduce those effective government subsidies on Wall Street trading. It requires certain types of derivatives to be pushed out of insured banks into another part of the bank that does not benefit from federal backing. Typically, most of a bank’s activities take place inside its insured subsidiaries.
In the end, the rule applies only to a small selection of derivatives. And the banks have been given until July 2015 to comply.
Even so, the banks have not stopped pressing for changes to the rule. Citigroup even helped write a piece of legislation in the House that would exempt still more types of derivatives. (Citigroup declined to comment.) The banks have opposed the push-out rule because they say it will make their trading less efficient. They have also contended that pushing out swaps will make the system riskier because the moved swaps will end up in less-regulated entities that the authorities might not support in times of crisis, a view that some regulators have shared.
Though the banks have long had a strong aversion to the idea of pushing out derivatives, something appears to be changing. In recent days, financial media have reported that banks have started to shift substantial amounts of derivatives trades into offshore affiliates that the parent banks do not guarantee. In other words, Wall Street is now actively pushing out swaps. It is not clear whether these moved swaps would originally have been done within the banks’ insured subsidiaries. But still, the banks are moving them into affiliates that have less support, which is exactly the sort of shift the push-out rule envisions.
So why are the banks doing this? In short, they are trying to avoid other derivatives regulations that are unrelated to the push-out rule.
Specifically, the banks want to reduce the impact of new rules, also part of Dodd-Frank, that aim to improve pricing transparency in the derivatives markets.
Trades done through the banks’ nonguaranteed offshore affiliates are more likely to be beyond the reach of the American transparency overhaul.
One interpretation of all this is that Wall Street simply dislikes the transparency rules more than the idea of pushing out swaps.
Another reading is that big banks will say anything to weaken regulation — even if they contradict themselves.