Financial Reform Rulemaking Gets Underway With Mega-Banks Lobbying For Weaker Derivatives Rules

One of the legitimate criticisms of the Dodd-Frank financial regulatory reform bill that passed this year is that it leaves a lot of the details of reform up to regulators, instead of laying out hard-and-fast rules. There are pros and cons to this approach, but one of the big drawbacks is that the rule-making happens when the subject has faded from public view, giving the financial services industry even more influence over the process than it already has.

Case in point, the country’s biggest banks have been meeting with officials at the Federal Reserve in an attempt to shape the new rules governing derivatives trading:

Goldman Sachs Group Inc., Citigroup Inc. and others have also discussed tough rules for derivatives with government officials. Citi executives, meeting with the Fed on Aug. 18, expressed concerns about the effect of the new rules on U.S. firms. “Citigroup representatives also expressed concerns about a narrow interpretation of the definition of hedging and the importance of retaining their ability to hedge across markets,” the meeting summary prepared by the Fed said.

Non-financial companies and lobbying groups are also trying to influence the new derivatives rules, including the American Petroleum Institute and the U.S. Chamber of Commerce.

First, I’m glad to see that these meetings were disclosed relatively quickly. Other bank regulators, including the FDIC, have been planning to make a concerted effort to disclose their meetings with private sector representatives regarding the implementation of Dodd-Frank, and it’s good to see the Fed follow suit.

But on to the substance. The derivatives title of Dodd-Frank is one of the better parts of the bill, bringing much-needed transparency to an unregulated market and restricting some of the riskier derivatives trading in which banks can engage, by forcing them to move certain activities into a separately capitalized subsidiary (although this provision was watered down from a much-stronger one at the very last minute). But activities that qualify as related to hedging risk don’t have to be walled off.

Therefore, it’s in the banks’ interest to have as much activity as possible qualify as hedging, which is what these meetings seem to have been about. But the wider these definitions are, the less effective Dodd-Frank is going to be and the more risky trading will occur in the heart of the financial system. The added lobbying of the Chamber and API, which both falsely portrayed the effect that financial regulation would have on corporations while negotiations were ongoing, is only going to tip the scales in favor of a wider definition and more risk in the system.

If regulators don’t craft strong rules during this implementation stage, financial reform isn’t going to amount to much. And, sadly, there’s no logical counterweight that has as much at stake in the discussion.