Banks Vulnerable to Losing $464 Trillion Swaps Business

Financial reform legislation is still in flux but two Senate proposals on the table now, if taken together, create a scenario where banks could get pushed out of the $464 trillion swaps business entirely.
By Dan Freed ,

NEW YORK (

TheStreet

) -- Could U.S. banks actually lose the swaps business entirely?

Whatever you think about financial reform, it is hard to believe that U.S. legislators would put a proposal on the table that would bar the nation's banks from participating in a market that its major trade group, the International Swaps and Derivatives Association, calculated at $464 trillion globally in 2009.

But Cory Strupp, lobbyist at the Securities Industry and Financial Markets Association (SIFMA), another key Wall Street trade group that counts

Goldman Sachs

(GS) - Get Report

,

JPMorgan Chase

(JPM) - Get Report

Morgan Stanley

(MS) - Get Report

Bank of America

(BAC) - Get Report

and

Citigroup

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among its members, says legislation working through Congress could be interpreted as doing just that.

Strupp says the proposal on derivatives reform that passed the Senate Agriculture Committee Wednesday "pretty clearly would require banks to move their swap business out of the bank and into a separate affiliate."

However, Strupp says that, taken together with another provision in legislation that passed the Senate Banking Committee last month, it would be possible to conclude banks would be required to move the swaps business not just out of the bank but out of the bank holding company as well.

The Senate Agriculture proposal states in

section 106

that institutions receiving federal assistance in any form, including borrowings from the discount window as well as the support of guarantees from the

Federal Deposit Insurance Corp.

, cannot be in the swaps business. Banks, however, could theoretically resolve this issue by moving their swaps businesses into affiliates that would still be part of the larger bank holding company, which is a separate legal entity.

That's where

section 1155 of the Senate Banking bill

comes into play. It would guarantee the debts of bank holding companies as well, rendering that workaround ineffective.

Taken together, the proposals "would essentially take U.S. banks out of the swaps business," Strupp says.

Strupp thinks the combined effect of the bills was not intentional, and he hopes it will be resolved ahead of the full Senate vote, which could come in the next two weeks.

Liz Friedlander, spokeswoman for Senator Blanche Lincoln (D., Ark.), chair of the Senate Agriculture Committee, wrote via e-mail that the issue, "is currently being discussed in the Agriculture Committee's negotiations with Banking."

When I sent back an e-mail asking if "discussed" meant "fixed," she wrote "it's being discussed." A Senate Banking Committee spokesman declined to comment.

JPMorgan boss Jamie Dimon told analysts earlier this month that derivatives reform proposals could cost the bank up to $2 billion in annual revenues.

However, Dimon's comments came before lobbyists had seen the "discussion draft," of the legislation that passed the Agriculture Committee Wednesday, which caught Wall Street completely off guard, Strupp says.

Presumably, moving banks out of the swaps business entirely would cost JPMorgan far more than $2 billion in annual revenues. A spokesman for the bank did not respond to an e-mail I sent him asking this question.

Dick Bove, analyst at Rochdale Securities, says the effect of moving U.S. banks out of the swaps business would be "staggering" -- so much so he has a hard time believing it could come to pass.

For example, if it precluded banks from arranging currency swaps, it would harm international trade, Bove explains. That's because companies that sell products abroad use the swaps to prevent wild swings in foreign exchange rates from impacting their profits.

"I can't imagine anything more negative. It's simply just another example of the fact that there is absolutely no understanding in Washington concerning how the financial industry in the U.S. operates," Bove said.

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Written by Dan Freed in New York

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