Section 716 of the Dodd-Frank Act (“DFA”), commonly called the “Swaps Push-Out Rule,” has been a point of contention from the time of its enactment in 2010.  Last month, this provision garnered another round of attention (contention?) when it was amended and “repealed” or “substantially repealed,” depending upon one’s view of financial markets and the like.  In this posting, we focus on five questions (and answers) that we believe will be of interest to buy-side market particpants – including credit officers, corporate treasury professionals, non-swap dealer banks, and the lawyers and compliance professionals who support them –  trying to understand the current state of play with respect to this statutory provision.

1)  What Was the Original Swaps Push-Out Rule All About?

As originally enacted in 2010, Section 716 of the DFA prohibited the provision of Federal assistance to a Federal depository institution that was a swap dealer or a security-based swap dealer (a “Swap Dealer Bank”), unless that Swap Dealer Bank limited its swap* activities to:

1) Using swaps for hedging or risk mitigation purposes; and

2) Dealing activities that related to interest rate swaps, over-the-counter foreign exchange derivatives, and certain credit default swaps.

*The term “swap” refers to both swaps and security-based swaps.

The effect of this statutory provision was to require a Swap Dealer Bank to “push out” all of its non-conforming swap activities (i.e., activities that did not conform with these limitations) into a separate entity that would not be eligible for Federal assistance.  In the vernacular,  Section 716 was called the “swaps push-out rule” and its fundamental purpose was to prevent a taxpayer bailout of what Congress perceived to be the riskiest swap activities that may be engaged in by a Swap Dealer Bank.

Some market participants felt that the swaps push-out rule did not go far enough to prevent a taxpayer bailout of swap activities engaged in by by financial institutions.  Other market particpants felt that Section 716 was poorly drafted and would unecessarily increase costs of swap trading for both Swap Dealer Banks and their buy-side customers.  There were many other views – in between and far away – in every possible direction.

2)  How did the Swaps Push-Out Rule change in December 2014?

In December 2014, an omnibus spending bill was enacted by Congress and signed into law by President Obama.  A provision in that bill amended Section 716, so as to ease the limitations on the types of swap activities that could be engaged in by a Swap Dealer Bank within its Federally assisted banking entity.  Under the amended version of the Swaps Push-Out Rule, a Swap Dealer Bank will be required to push out activity solely in respect of certain “structured finance swaps”.  The amendments define the term “structured finance swap” to mean a swap on an asset-backed security (or a group or index primarily comprised of such securities).

The amendments will not require a push-out of structured finance swaps on asset-backed securities “of a credit quality and of a type or category”  that the prudential (i.e., U.S. banking) regulators authorize as being acceptable.  (We are not aware of the existence of such authorizing regulations.)  The amendments do not affect the ability of a Swap Dealer Bank to use swaps – including structured finance swaps – for hedging or risk management purposes.

3) How will the amendments affect the buy-side?

Practically speaking, most buy-side market participants did not enter into the types of swaps that were subject to the requirements of the “old” swaps push-out rule.  So, in the first instance, we do not expect that much will change for most of the buy-side, as a result of the amendments to the swaps-push out rule.

After Dodd Frank was enacted, certain buy-side transactions (such as those involving swaps related to certain physical commodities) with certain Swap Dealer Banks had to be entered into with an affiliate of that Swap Dealer Bank, rather than the Swap Dealer Bank itself.  Most of those affiliates did not receive Federal assistance and, at least in theory, would not be the beneficiary of a taxpayer bailout in the event of a Swap Dealer Bank’s failure. However, these changes to the structure of a Swap Dealer Bank’s trading activities were not entirely driven by the “old” swaps push-out provision (i.e., as in effect prior to the December 2014 amendments) – there were other factors (including the prospective implementation of the Volcker Rule) that contributed to these structural changes at the Swap Dealer Banks.  The amendments to the swaps push-out rule did not affect those contributing factors.  So, the amended swaps push-out rule is not likely to have an effect on the trading relationships that buy-side participants may have with such affiliates of the Swap Dealer Banks.

Separately, some of the larger, more sophisticated non-Swap Dealer Banks may have been able to engage in a relatively modest level of swap activities that the Swap Dealer Banks would have pushed out to their affiliates under the “old” swaps push-out rule.  As a result of the recent amendments, those non-Swap Dealer Banks may have lost what could have been a “competitive advantage” with respect to dealing in the affected swaps (namely, being able to price such swaps based upon the credit quality of their “Federally assisted balance sheet”).  We suspect that may be more of a theoretical issue, since it seems unlikely that there were a large number of non-Swap Dealer Banks with such a strong balance sheet that were planning to pursue this type of a growth strategy.  (Although, that is admittedly entirely conjecture on our part and certainly not a legal issue.)  Perhaps more importantly, we do not think that the vast majority of buy-side market participants would have been trading in those swaps, as noted earlier in this posting.

Finally, if there is stress at (or a failure of) a Swap Dealer Bank, then any buy-side firm that is a U.S. taxpayer may be adversely affected by the provision of Federal assistance (i.e., a taxpayer bailout) in the future.  We acknowledge that possibility.  But, ultimately, that is a policy issue that is beyond the focus of this blog.

4) When will the swaps push-out rule go into effect?

On July 16, 2015, although compliance for some banks has been delayed by their regulators.  The December 2014 amendments did not affect the effective date for the “rule,” which brings us to our final question.

5) Is the “swaps push-out rule” really a rule?

No and neither is the Volcker Rule.  They are both statutory provisions.  The use of the term “rule” creates an unnecessary drafting issue for those of us who have to write about final regulations that are issued pursuant to an improperly “named” statutory provision.  We know that most of you don’t care – and thank you for entertaining that rant.

Good day.  Good or bad amendments? Meaningful or not really at all? You decide…only time will tell. DR2