Banks that arrange derivative trades with public pension plans as well as states and municipalities may be barred from giving to the campaigns of politicians with the power to award them work, according to a proposed CFTC rule.
The Commodity Futures Trading Commission’s proposal is among the first aimed at the municipal derivatives business because of the Dodd-Frank financial overhaul. Other proposals seek to prevent banks from trading with officials unable to gauge the risks, and from peddling deals that aren’t in clients’ best interests.
The proposed ban on political donations, aimed at a practice known as “pay-to-play,” would bring the rules for the derivatives business in line with those for the rest of the municipal-finance industry. Underwriters have been banned from giving to their public-official clients since 1994, and local government financial advisers may also face restrictions as a result of the regulatory overhaul.
There will be some proposed exemptions, including for smaller contributions, the commission said.
The proposal, if approved by the commission this week, would be opened to public comment before it is completed.
The new rules on derivatives known as swaps, in which two parties agree to exchange payments based on underlying assets or indexes, are a response to the fallout from the financial crisis. When that struck, derivatives sold as a way of saving taxpayers money backfired and hit municipalities with soaring interest bills. The trades have since cost public agencies and non-profits more than $4 billion in fees to back out of them, according to data compiled by Bloomberg.
The regulators also are drafting rules to implement special protections required under Dodd-Frank for government pension plans, endowment funds, states and municipalities. The CFTC said these rules would prevent banks from entering into swap transactions with such clients unless it believes they have a representative able to examine the risks, act in its best interests and evaluate whether the deals are being sold at a fair price.
In cases where banks recommend that municipalities enter into swap trades, the CFTC said proposed rules would require them to make “reasonable efforts” to ensure that the trades are in their customers’ best interests.