A Useful Distinction on the End-User Exemption

Gregory Meyer at the Financial Times does some helpful reporting on the different strategies being pursued by commodity companies in the fight over the regulations being written to implement the Dodd-Frank reform of the OTC derivatives markets. Companies including Cargill, Shell, Hess and Land O’Lakes produce, process, and ship physical commodities, and they trade financial derivatives to hedge commercial risk stemming from that business in the physical commodities. These are all activities covered by the end-user exemption written into the legislation. But many of them also operate a swap dealer business, selling financial derivatives to other companies, making financial markets, and betting money on their own proprietary trading portfolio. This is the activity that the legislation did not exempt.

Most of the public debate has been been framed by companies like Shell which have been pushing a false choice on regulators. Because they own some businesses producing physical commodities, they want the regulators to designate them in toto as an end-user, exempting them entirely from the regulations that cover swap dealers. They run a swap dealing business, but they are asking the regulators to ignore it because it is housed inside a company that also produces physical commodities. (See my post on Shell here.)

This is the dangerous loophole I was referring to in the quote in Meyer’s piece. Once written into the regulations, any financial firm could take advantage of it by starting a physical business alongside its financial business.

It’s as if a cell phone company wanted exemption from cell phone regulations because it’s product contains a camera and so is not a cell phone. The regulator should not care about the camera. They should care about the cell phone. If the product makes calls on a cellular system, it’s a cell phone and, in that capacity, it should be subject to the regulations governing cell phones. What else the product does is beside the point.

On the same principle, the same regulations should apply to swap dealer businesses, whether they come as a stand-alone business or wrapped together with a physical commodity business operated under the same corporate parent.

Until recently, Shell and similarly situated companies have refused to acknowledge any of this, and they have had some success in framing the public debate as if a company was either (i) in the physical business — aka an end-user, or (ii) in the financial business — aka a swap dealer. They have refused to acknowledge that a company can be both, and they hoped to shape the regulations to align with this unreal framework.

Along comes Cargill to finally acknowledge the obvious. Cargill is a big end-user. And Cargill runs a swap dealer business. They do both. Cargill’s realism is a breath of fresh air.

Cargill has its own lobbying agenda, which is to avoid a potentially dangerous consequence of Shell’s false dichotomy. After all, if a company can only be one or the other, there is a danger that some end-users with a swap dealer business will be labeled a dealer and not an end-user. Then the regulations will apply not only to the company’s dealing activities, but also to the company’s commerical hedging activities. That’s what Cargill wants to avoid. It wants the regulator to make a distinction between its swap dealer business and the rest of its business. As Gregory Meyer reports, “Cargill said the new capital rules should apply only to its swap dealing division.”

How to write the regulations to respect the distinctions within a company is a difficult task. But we can only get started if we begin with a realistic perspective. In that respect, Cargill has done the public discussion a useful service.

2 Trackbacks

  1. […] end-users also conduct finance business underneath the same holding company–see here and here. Similarly, many banks provide non-financial services underneath the same holding company–see […]

  2. […] into the business of dealing in derivatives or otherwise running financial businesses—see here, here, and here. Well, it works the other way around, too. Companies well known as banks with a clear […]

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