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Regulation

Swaps rule change allows banks to do more swaps activity, GAO report says

Sen. Elizabeth Warren, D-Mass.

J.P. Morgan Chase, Citibank, Goldman Sachs and Bank of America were able to retain more than $10 trillion of derivatives following changes to a Dodd-Frank Wall Street Reform and Consumer Protection Act provision that would have covered more swaps activities, according to a report issued by the Government Accountability Office on Friday.

The report was ordered by Sen. Elizabeth Warren, D-Mass., and House Oversight and Government Reform Ranking Member Elijah E. Cummings, D-Md., following their investigation of the changes that were part of an omnibus spending package in 2014.

Section 716 of Dodd Frank, which is also known as the "swaps push-out rule," requires banks registered as swap dealers to stop certain activities in order to remain eligible for federal financial assistance, but allows them to "push out" such activities to non-bank affiliates within the same bank holding company. It originally covered certain equity, commodity and credit default swaps activities and would have affected 11 banks, but it was amended in 2014 to cover only certain swap activity based on asset-backed securities.

"Proponents of section 716 sought to prohibit banks from engaging in riskier swap activities that could cause the banks to need federal assistance backed by taxpayers. Opponents of section 716 maintained that swaps trading by banks did not significantly contribute to the financial crisis," the GAO report said, noting that derivatives "can exacerbate a firm's financial distress caused by other losses."

As a result of the changes to Section 716, "taxpayers are now potentially on the hook to bail out these institutions if these risky swaps trades go bad," Ms. Warren and Mr. Cummings said in a joint statement. "This repeal provision was risky when it passed, but if the Trump administration achieves its goal of getting rid of other important Dodd-Frank protections, the risks will be even higher."

The GAO's report, Perspectives on the Swaps Push-Out Rule, found that the amended rule affected the four U.S. banks and caused them to push out an estimated $265 billion of swaps, less than 1% of their total derivatives, as of Sept. 30, 2016.

The original rule would have affected 11 U.S. banks, including the four, and affected an estimated $10.5 trillion, or about 6% of their total derivatives, GAO found.

"Under the amended version, banks moved their covered swap activities to non-bank affiliates, requiring the affiliates and clients to incur legal and operational costs. Banks and end-users told GAO that moving the swaps can increase their risks and, in turn, costs. Such risks and costs likely would have been greater under the original version because of its broader scope," GAO said.

Other Dodd-Frank provisions help mitigate some of the risks, and federal banking regulators "are continuing to develop resolution strategies" that would avoid federal assistance and help avoid value destruction, the report said.