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115th Congress    }                                   {       Report
                        HOUSE OF REPRESENTATIVES
 2d Session       }                                   {       115-893

======================================================================



 
                        DERIVATIVES FAIRNESS ACT

                                _______
                                

 August 7, 2018.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______
                                

Mr. Hensarling, from the Committee on Financial Services, submitted the 
                               following

                              R E P O R T

                             together with

                             MINORITY VIEWS

                        [To accompany H.R. 5323]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Financial Services, to whom was referred 
the bill (H.R. 5323) to amend the Dodd-Frank Wall Street Reform 
and Consumer Protection Act to establish an exemption from the 
credit valuation adjustment calculation for uncleared 
derivatives transactions with end-users so that United States 
companies are not disadvantaged, and for other purposes, having 
considered the same, report favorably thereon with an amendment 
and recommend that the bill as amended do pass.
    The amendment is as follows:
  Strike all after the enacting clause and insert the 
following:

SECTION 1. SHORT TITLE.

  This Act may be cited as the ``Derivatives Fairness Act''.

SEC. 2. CREDIT VALUATION ADJUSTMENT RELIEF.

  (a) In General.--The Dodd-Frank Wall Street Reform and Consumer 
Protection Act (12 U.S.C. 5361 et seq.), is amended by inserting after 
section 176 the following new section:

``SEC. 177. CREDIT VALUATION ADJUSTMENT.

  ``Prudential risk-based capital requirements and generally applicable 
risk-based capital requirements established by the appropriate Federal 
banking agencies shall not apply a fair value adjustment to reflect 
counterparty credit risk in valuation of over-the-counter derivative 
contracts with respect to transactions with a counterparty that--
          ``(1) is described under section 2(h)(7)(A) of the Commodity 
        Exchange Act;
          ``(2) is a person or class of persons that meets any 
        qualifications required by a regulation issued by the Commodity 
        Futures Trading Commission with respect to such person or class 
        of persons qualifying for an exemption under section 4(c)(1) of 
        the Commodity Exchange Act from the requirements of section 
        2(h)(1)(A) of such Act; or
          ``(3) is an affiliate that meets the requirements for an 
        exception under section 2(h)(7)(D) of the Commodity Exchange 
        Act.''.
  (b) Conforming Amendment.--The table of contents in section 1(b) of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act (12 
U.S.C. 5301 note) is amended by inserting after the item relating to 
section 176 the following new item:

``Sec. 177. Credit valuation adjustment.''.

                          Purpose and Summary

    On March 19, 2018, Representative Warren Davidson 
introduced H.R. 5323, the ``Derivatives Fairness Act''. H.R. 
5323 amends Title I of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act) to add a new section 
177 entitled ``Credit Valuation Adjustment.'' This new section 
would exempt non-cleared derivatives with certain 
counterparties commonly described as ``end-users'' from the 
costly Credit Valuation Adjustment (CVA) capital charge.

                  Background and Need for Legislation

    The goal of H.R. 5323 is to eliminate unnecessary and 
burdensome costs for certain users of derivatives, commonly 
known as ``end-users'' to ensure that U.S. companies are not at 
a competitive disadvantage versus end-users operating in other 
global markets so they can better manage business risks, help 
sustain growth, create jobs, and provide goods and services to 
the economy with greater predictability in the price of those 
goods and services.
    During the financial crisis, banks suffered significant 
counterparty credit risk (CCR) losses on their over-the-counter 
(OTC) derivatives contracts, which came mostly from fair value 
adjustments on derivatives, rather than counterparty defaults. 
But hedging activity by end-users did not contribute to the 
financial crisis; it also does not create meaningful systemic 
risk, as end-users comprise less than 10 percent of the 
notional amount of the OTC derivatives market.
    Under the Basel II framework, CCR was designed to 
capitalize for default and migration risk rather than potential 
accounting losses. As a result, the Basel Committee on Banking 
Supervision introduced a new capital charge to address this 
regulatory gap in Basel III. The updated Credit Valuation 
Adjustment (CVA) capital charge was intended to improve banks' 
resilience against potential mark-to-market losses relating to 
variability in counterparty credit risk for non-cleared 
derivatives trades. The CVA applies only to non-cleared trades, 
as exposures toward central counterparties are exempt from the 
CVA charge. Banks are permitted to reduce their CVA exposures 
through hedging by entering into credit default swaps (CDS).
    In July 2013, the Board of Governors of the Federal Reserve 
System and other banking agencies approved final rules to enact 
the U.S. regulatory capital rules as part of a comprehensive 
framework that includes the adoption of the Basel III regime as 
well as capital provisions from the Dodd-Frank Act. Meanwhile, 
the European Union (EU) adopted their Basel III standards 
through the Capital Requirements Regulation and Capital 
Requirements Directive, published in June 2013. In their 
regulations, however, the EU diverged from Basel III--and the 
U.S. implementation of Basel III--by adopting a CVA capital 
charge that exempts transactions between EU-based banks and 
non-financial corporations in order to reflect the exemption 
under the European Market Infrastructure Regulation (EMIR) to 
centrally clear derivative transactions for non-financial 
corporates. As a result, U.S. banks that have to apply a CVA 
charge for uncleared end-user derivatives contracts are at a 
competitive disadvantage vis-a-vis European banks. For 
instance, an end-user would likely find it cheaper to hedge 
interest rate risk with an EU dealer rather than a US dealer.
    Additionally, the CVA charge for uncleared end-user 
derivatives transactions is inconsistent with end-user relief 
included in Title VII of the Dodd-Frank Act as well as 
amendments enacted in 2015. Title VII of the Dodd Frank Act 
provides exemptions from the clearing and margin requirements 
from certain qualifying derivatives transactions for end-users, 
but derivatives by end-users with U.S. banks still are 
subjected to the CVA capital charge. Again, at a competitive 
disadvantage as EU regulations align end-user relief with the 
CVA exemption.
    End-users typically require fairly-priced, tailor-made and 
widely offered derivative products to protect core business 
activities from commercial and financial risk. End-users 
executing uncleared swaps with banking organizations that are 
subject to the CVA are likely to see increased transaction 
costs as the dealer bank is likely to pass along the CVA 
capital charge in the form of higher fees to execute these 
transactions. As part of testimony before the Subcommittee on 
Capital Markets, Securities, and Investment in February 2018, 
Scott O'Malia, CEO of the International Swap and Derivatives 
Association (ISDA), stated: ``When banks that are subject to 
the CVA execute non-cleared swaps with end-users, the end-users 
are likely to see increased transaction costs since the banking 
organizations generally pass through the costs of the CVA 
capital charge in the form of higher pricing on their uncleared 
swap transactions.''
    Further, Tom Deas, Chairman of the National Association of 
Corporate Treasurers testified before the Capital Markets 
Subcommittee in February 2018 on behalf of the Coalition for 
Derivatives End-Users that: ``The lack of a CVA exemption in 
the United States significantly reduces the benefits of the 
statutory exemptions from clearing and margin requirements, 
which were granted by Congress under Dodd-Frank. An exemption 
would put U.S. businesses on equal footing with their non-U.S. 
counterparts.''

                                Hearings

    The Committee on Financial Services held a hearing 
examining matters relating to H.R. 5323 on February 14, 2018.

                        Committee Consideration

    The Committee on Financial Services met in open session on 
March 21, 2018, and ordered H.R. 5323 to be reported favorably 
to the House without amendment by a recorded vote of 34 yeas to 
26 nays (recorded vote no. FC-174), a quorum being present.

                            Committee Votes

    Clause 3(b) of rule XIII of the Rules of the House of 
Representatives requires the Committee to list the record votes 
on the motion to report legislation and amendments thereto. A 
motion by Chairman Hensarling to report the bill favorably to 
the House without amendment was agreed to by a recorded vote of 
34 yeas to 26 nays (Record vote no. FC-174), a quorum being 
present. An amendment offered by Representative Kihuen was not 
agreed to by a recorded vote of 25 ayes to 35 nays (FC-173), a 
quorum being present.




[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]






                      Committee Oversight Findings

    Pursuant to clause 3(c)(1) of rule XIII of the Rules of the 
House of Representatives, the findings and recommendations of 
the Committee based on oversight activities under clause 
2(b)(1) of rule X of the Rules of the House of Representatives, 
are incorporated in the descriptive portions of this report.

                    Performance Goals and Objectives

    Pursuant to clause 3(c)(4) of rule XIII of the Rules of the 
House of Representatives, the Committee states that H.R. 5323 
will reduce transaction costs and provide regulatory fairness 
by eliminating the CVA charge for uncleared end-user 
derivatives contracts.

   New Budget Authority, Entitlement Authority, and Tax Expenditures

    In compliance with clause 3(c)(2) of rule XIII of the Rules 
of the House of Representatives, the Committee adopts as its 
own the estimate of new budget authority, entitlement 
authority, or tax expenditures or revenues contained in the 
cost estimate prepared by the Director of the Congressional 
Budget Office pursuant to section 402 of the Congressional 
Budget Act of 1974.

                 Congressional Budget Office Estimates

    Pursuant to clause 3(c)(3) of rule XIII of the Rules of the 
House of Representatives, the following is the cost estimate 
provided by the Congressional Budget Office pursuant to section 
402 of the Congressional Budget Act of 1974:

                                     U.S. Congress,
                               Congressional Budget Office,
                                      Washington, DC, June 1, 2018.
Hon. Jeb Hensarling,
Chairman, Committee on Financial Services,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 5323, the 
Derivatives Fairness Act.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Kathleen 
Gramp.
            Sincerely,
                                                Keith Hall,
                                                          Director.
    Enclosure.

H.R. 5323--Derivatives Fairness Act

    Summary: H.R. 5323 would prohibit the federal financial 
regulators from requiring banks to hold capital against certain 
derivative contracts. Under current law, the calculation of a 
bank's capital requirement includes amounts for some derivative 
contracts.
    CBO estimates that implementing H.R. 5323 would, on net, 
increase the deficit by $2 million over the 2019-2028 period. 
That estimate includes an increase in direct spending of $2 
million and an increase in revenues of less than $500,000. 
Because enacting the bill would increase direct spending and 
revenues, pay-as-you-go procedures apply.
    CBO estimates that enacting H.R. 5323 would not increase 
net direct spending by more than $2.5 billion or on-budget 
deficits by more than $5 billion in any of the four consecutive 
10-year periods beginning in 2029.
    H.R. 5323 contains no intergovernmental or private-sector 
mandates as defined in the Unfunded Mandates Reform Act (UMRA).
    Basis of estimate: For this estimate, CBO assumes that the 
bill will be enacted near the end of 2018. The budgetary 
effects of H.R. 5323 stem from the small chance that the 
Federal Deposit Insurance Corporation (FDIC) would incur 
additional costs to resolve financial institutions that fail.
    This cost estimate is based on the analysis underlying 
projections for the FDIC's financial resolution programs 
included in CBO's April 2018 baseline. Those projections 
incorporate a weighted probability of different outcomes for 
future failures of financial institutions. Most of those 
outcomes have a very small probability of occurring, but if 
they did, the costs to the FDIC's Deposit Insurance Fund (DIF) 
or the Orderly Liquidation Fund (OLF) would be very large.\1\ 
On balance, CBO estimates that the federal regulations that 
require banks to maintain certain levels of capital and 
liquidity lower the FDIC's costs for resolving failed financial 
institutions because they increase the proportion of losses 
that will be absorbed by shareholders and other creditors.
---------------------------------------------------------------------------
    \1\The DIF, which is funded by premiums paid by member 
institutions, resolves the assets of failed insured depository 
institutions and insures certain deposits up to $250,000 per depositor. 
The OLF was established to resolve failures of certain large, 
systemically important institutions--banks and nonbanks. In the event 
of a failure, the OLF's costs would largely be recouped by assessments 
(which would be recorded as revenues in the federal budget) collected 
from other large financial institutions.
---------------------------------------------------------------------------
    Under H.R. 5323, banks would no longer be required to 
account for some derivatives in their calculation of capital 
ratios that are based on what are known as a bank's risk-
weighted assets (RWA). Only institutions bound by the RWA ratio 
would be affected by the bill.
    On the basis of publicly available information about the 
amount of capital held by banks for affected derivatives, CBO 
estimates that implementing H.R. 5323 would, on net, increase 
deficits by $2 million over the 2019-2028 period. That estimate 
includes an increase in direct spending of $2 million and an 
increase in revenues of less than $500,000 for the OLF. Those 
budgetary effects are small relative to the $14.2 billion net 
cost that CBO projects for the OLF over that 10-year period. 
CBO estimates that most of the cost of H.R. 5323 would be 
offset after 2028 by an increase in fees paid by financial 
institutions. Finally, CBO estimates that implementing the bill 
would have no significant net effect on the DIF.
    Pay-as-you-go considerations: The Statutory Pay-As-You-Go 
Act of 2010 establishes budget-reporting and enforcement 
procedures for legislation affecting direct spending or 
revenues. Because H.R. 5323 would affect direct spending and 
revenues (as discussed above) pay-as-you-go procedures apply.
    Increase in long-term direct spending and deficits: CBO 
estimates that enacting H.R. 5323 would not increase net direct 
spending by more than $2.5 billion or on-budget deficits by 
more than $5 billion in any of the four consecutive 10-year 
periods beginning in 2029.
    Mandates: H.R. 5323 contains no intergovernmental or 
private-sector mandates as defined in UMRA.
    Estimate prepared by: Federal Costs: Kathleen Gramp 
(Orderly Liquidation Fund) and Sarah Puro (Deposit Insurance 
Fund); Mandates: Jon Sperl.
    Estimate reviewed by: Kim P. Cawley; Chief, Natural and 
Physical Resources Cost Estimates Unit; H. Samuel Papenfuss; 
Deputy Assistant Director for Budget Analysis.

                       Federal Mandates Statement

    This information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995.
    The Committee has determined that the bill does not contain 
Federal mandates on the private sector. The Committee has 
determined that the bill does not impose a Federal 
intergovernmental mandate on State, local, or tribal 
governments.

                      Advisory Committee Statement

    No advisory committees within the meaning of section 5(b) 
of the Federal Advisory Committee Act were created by this 
legislation.

                  Applicability to Legislative Branch

    The Committee finds that the legislation does not relate to 
the terms and conditions of employment or access to public 
services or accommodations within the meaning of the section 
102(b)(3) of the Congressional Accountability Act.

                         Earmark Identification

    With respect to clause 9 of rule XXI of the Rules of the 
House of Representatives, the Committee has carefully reviewed 
the provisions of the bill and states that the provisions of 
the bill do not contain any congressional earmarks, limited tax 
benefits, or limited tariff benefits within the meaning of the 
rule.

                    Duplication of Federal Programs

    In compliance with clause 3(c)(5) of rule XIII of the Rules 
of the House of Representatives, the Committee states that no 
provision of the bill establishes or reauthorizes: (1) a 
program of the Federal Government known to be duplicative of 
another Federal program; (2) a program included in any report 
from the Government Accountability Office to Congress pursuant 
to section 21 of Public Law 111-139; or (3) a program related 
to a program identified in the most recent Catalog of Federal 
Domestic Assistance, published pursuant to the Federal Program 
Information Act (Pub. L. No. 95-220, as amended by Pub. L. No. 
98-169).

                   Disclosure of Directed Rulemaking

    Pursuant to section 3(i) of H. Res. 5, (115th Congress), 
the following statement is made concerning directed rule 
makings: The Committee estimates that the bill requires no 
directed rule makings within the meaning of such section.

             Section-by-Section Analysis of the Legislation


Section 1. Short title

    This section cites H.R. 5323 as the ``Derivatives Fairness 
Act''.

Section 2. Credit valuation adjustment relief

    This section amends the Dodd-Frank Wall Street Reform and 
Protection Act to ensure that regulations issued by the federal 
banking agencies to promulgate minimum risk-based capital 
requirements do not apply a fair value adjustment to reflect 
counterparty credit risk in valuation of OTC derivatives 
contracts for qualifying transactions with corporate end-users.

         Changes in Existing Law Made by the Bill, as Reported

    In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (existing law 
proposed to be omitted is enclosed in black brackets, new 
matter is printed in italics, and existing law in which no 
change is proposed is shown in roman):

         Changes in Existing Law Made by the Bill, as Reported

  In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (new matter is 
printed in italic and existing law in which no change is 
proposed is shown in roman):

       DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT


SECTION 1. SHORT TITLE; TABLE OF CONTENTS.

  (a) Short Title.--This Act may be cited as the ``Dodd-Frank 
Wall Street Reform and Consumer Protection Act''.
  (b) Table of Contents.--The table of contents for this Act is 
as follows:

Sec. 1. Short title; table of contents.
     * * * * * * *

                      TITLE I--FINANCIAL STABILITY

     * * * * * * *

Subtitle C--Additional Board of Governors Authority for Certain Nonbank 
             Financial Companies and Bank Holding Companies

     * * * * * * *
Sec. 177. Credit valuation adjustment.

           *       *       *       *       *       *       *


TITLE I--FINANCIAL STABILITY

           *       *       *       *       *       *       *


Subtitle C--Additional Board of Governors Authority for Certain Nonbank 
Financial Companies and Bank Holding Companies

           *       *       *       *       *       *       *


SEC. 177. CREDIT VALUATION ADJUSTMENT.

  Prudential risk-based capital requirements and generally 
applicable risk-based capital requirements established by the 
appropriate Federal banking agencies shall not apply a fair 
value adjustment to reflect counterparty credit risk in 
valuation of over-the-counter derivative contracts with respect 
to transactions with a counterparty that--
          (1) is described under section 2(h)(7)(A) of the 
        Commodity Exchange Act;
          (2) is a person or class of persons that meets any 
        qualifications required by a regulation issued by the 
        Commodity Futures Trading Commission with respect to 
        such person or class of persons qualifying for an 
        exemption under section 4(c)(1) of the Commodity 
        Exchange Act from the requirements of section 
        2(h)(1)(A) of such Act; or
          (3) is an affiliate that meets the requirements for 
        an exception under section 2(h)(7)(D) of the Commodity 
        Exchange Act.

           *       *       *       *       *       *       *


                             MINORITY VIEWS

    H.R. 5323 would allow megabanks to ignore risks from 
certain derivatives transactions when calculating their capital 
buffers that are supposed to prevent the bank's failure during 
adverse economic conditions. Specifically, the bill would 
exempt derivatives transactions with end-users that are not 
conducted through a clearing house from the credit valuation 
adjustment (CVA) to a bank's capital requirement.
    The CVA represents the change to the value of a derivative 
contract to account for the likelihood that the customer of the 
bank or counterparty might default on its obligations under the 
contract. Banks are required to account for these derivatives 
on a fair value basis, meaning that they have to periodically 
update the value of the derivative based on changes in their 
counterparty's default risk, among other factors. The Basel 
Committee on Banking Supervision (BCBS) found that during the 
2008 financial crisis roughly two-thirds of counterparty credit 
risk losses during the financial crisis resulted from bank 
writedowns of fair value in connection with CVA, while only 
one-third of such losses resulted from actual defaults.
    Consistent with the Basel III accords, U.S. banking 
regulators required that the largest banks, those with more 
than $250 billion in assets, hold capital to account for CVA to 
ensure they are better prepared if the party on the opposite 
side of a derivative transaction experiences a deterioration in 
creditworthiness or defaults on its obligation.
    H.R. 5323 would amend this requirement based entirely on 
the determination by the European Union to exclude CVA from the 
calculation of European banks' capital requirements under Basel 
III. Notably, European governments tend to provide 
significantly more support to prop up their banking sectors, as 
well as other industries, a practice that Democrats sought to 
end in the United States through the enactment of the Dodd-
Frank Act.
    Supporters of H.R. 5323 claim that relief is necessary 
because the differences in treatment of CVA between the United 
States and European Union have put U.S. derivatives end-users, 
like airlines and gas companies, at a competitive disadvantage 
relative to their European counterparts. U.S. regulators, 
however, determined that the risks that these counterparties 
pose to banks should be accounted for to promote the safety and 
soundness of the banking industry and to promote the public 
good.
    Importantly, H.R. 5323's supporters have offered no 
evidence of a competitive disadvantage. In fact, during a 
February 14, 2018 Capital Markets Subcommittee hearing on H.R. 
5323 and other proposals, a representative of the International 
Swaps and Derivatives Association testified that, ``we are 
trying to assess what the new Basel requirements would do to 
impact U.S. traders. And it is very important we do the 
economic analysis,'' (emphasis added). During the Committee's 
consideration of the bill, Rep. Kihuen offered a sensible 
amendment to ensure that Congress first receives such an 
economic analysis. Consistent with a bill from the 113th 
Congress that received unanimous approval in Committee and 
passed the House Floor by a vote of 353-24, Rep. Kihuen's 
amendment would have replaced H.R. 5323's carve out with a 
requirement that the Financial Stability Oversight Council 
(FSOC) conduct a study of the potential effects of the 
differences between the United States' and other jurisdictions' 
implementation of the CVA capital requirement under Basel III. 
Rep. Kihuen's amendment was rejected on party lines.
    H.R. 5323 is opposed by proponents of responsible banking 
practices, like Public Citizen and Americans for Financial 
Reform (AFR). In a letter to the Committee, AFR cautioned that, 
``we should not use the European banking system--which is 
generally recognized as significantly undercapitalized compared 
to the U.S. system as the standard for our banking and 
derivatives regulations. In the long run, U.S. banks will be 
more competitive when they are generally recognized as safe and 
sound.''
    For these reasons we oppose H.R. 5323.

                                   Maxine Waters.
                                   Carolyn B. Maloney.
                                   Stephen F. Lynch.
                                   Gregory W. Meeks.
                                   Ed Perlmutter.
                                   David Scott.
                                   Nydia M. Velazquez.
                                   Keith Ellison.
                                   Wm. Lacy Clay.
                                   Michael E. Capuano.
                                   Joyce Beatty.
                                   Al Green.

                                  [all]