Back to the Future: House Votes to Put Margin Exemption Back into Dodd-Frank

This week the U.S. House of Representatives voted 370-24 to amend Dodd-Frank to allow non-financial end users to be exempt from being required to post margin for OTC derivative trades. If you were following the saga of the final passage of Dodd-Frank, you may recall that, at the 11th hour, the margin exemption wording was pulled, leaving behind just the end-user clearing exemption. I assumed this was an attempt at trying to make the legalese more efficient, because if you don’t have to clear your trade, why would you post margin.

Well after the Fed and CFTC came out with draft margin rule proposals, it seemed clear that the intent was to protect the financial system by having trades that don’t clear backed by margin. The end-user community got to work and lobbied to put the exemption back in, so maybe the system does work.

It is hard to imagine that the Senate would not pass the amendment, so hopefully President Obama will be able to sign it into law soon. However, I believe that Swap Dealers may still want to collect margin for un-cleared trades to lower their capital charges; otherwise, they would have to charge more through a wider bid-offer spread or additional fees. In order to avoid the hassle of complying with un-cleared trades, some Swap Dealers may decide not to offer hedges that won’t clear. In the end, the economics of clearing vs. not clearing your trade may drive you to post margin to Swap Dealers, even if the law doesn’t require you to do so.