So Blanche Lincoln’s eleventh-hour introduction of a provision that would have required the banks to spin off their swaps desks into separate affiliates may just have been what allowed her to beat back that primary challenge from the left. I hadn’t been following its surprising survival or inevitable dilution that closely, and I was surprised recently to read that banks will be allowed to continue to trade “investment-grade” swaps. Given that “investment grade” is usually defined in terms of ratings, that seemed a little weird in light of Congress’ s very aggressive move to get rid of rating-dependent regulation at the federal level altogether in Sec. 939A of the bill, as discussed in my previous post.
Turning to the text of the conference report and working through a layer of definitions I won’t go into here, it seems that what people call the swap spinoff requirement of Sec. 716 has an exception for banks’ dealing and trading in swaps (other than CDS) that involve “rates or reference assets that are permissible for investment by a national bank under the paragraph designated as ‘Seventh’ of section 5136 of the Revised Statutes of the United States ( 12 U.S.C. 24).”
12 U.S.C. 24, in turn, doesn’t tell us exactly all the assets that are permissible for a national bank. It specifies some securities in which such a bank can invest and goes on to provide that national banks may purchase “investment securities” as that term is defined by the Comptroller of the Currency. And credit ratings lie at the heart of the Comptroller’s rules about what national banks can purchase. See 12 C.F.R. §§ 1.2-1.3. Indeed, the Comptroller’s use of ratings for this purpose – introduced in the 1930’s – is often cited as the canonical example of rating-dependent regulation.
So it seems that Congress is actually adopting a rating-dependent regulation to define its new swap-spinoff rule while at the same time instructing regulators to get rid of all rating-dependent regulation in Sec. 939A. I suppose the provisions aren’t exactly inconsistent, because Sec. 939A gives the regulators one year to eliminate rating-dependent regulation and there is a two-year period before the swaps desks have to be separated (Sec. 716(f)). And I’d be hard-pressed to identify a significant market in swaps other than CDS on investment-grade assets. But it still strikes me as a bit weird.
