CHICAGO--(BUSINESS WIRE)--Fitch Ratings believes that the swaps push-out rule, or "Lincoln amendment," to the Dodd-Frank Act (DFA) may ultimately constrain derivatives activity among the largest U.S. commercial banks, but its impact on bank credit profiles will likely be limited.
Under the rule, banks have the option to fully spin out their derivatives activity into an affiliated entity under their bank holding company, or split their derivatives activity so that activities permissible within a bank remain at the bank while only those that are required to be pushed out are housed in a separate affiliate. We think the latter is the most likely path given the volume of permissible activities within a bank and the significant costs of moving the entire derivatives business into another affiliate.
The push-out rule prohibits federal assistance to insured depositary institutions (IDIs) that deal in certain credit derivatives, as well as all equity, and most commodity derivatives. Since FDIC insurance and access to the discount window count as federal assistance, the rule effectively forces these activities out of a bank into separately capitalized swap entities. However, interest rate, currency, gold/silver, credit derivatives referencing investment-grade securities, and hedges are permissible activities within an IDI.
The large U.S. commercial banks that dominate derivatives activity in the U.S. already have separately capitalized affiliates that can house pushed out derivatives activity. Any additional capital requirements are likely to be incremental. However, clients that benefit from cross-derivative product netting at the bank would lose that benefit, as well as the operational efficiency of dealing with one counterparty for their derivatives activity. Derivative transactions at the affiliate would also be subject to separate collateral posting requirements.
Both Goldman Sachs and Morgan Stanley face little impact from the rule, as their derivatives activity is already conducted outside their bank subsidiaries. Therefore, we believe JPMorgan Chase, Bank of America, Citigroup and, to a lesser extent, Wells Fargo, would be affected the most from the push-out rule.
We note that the size and scope of activities to be restricted from banks is a fraction of the overall derivatives business of these firms. Our analysis indicates that the total notional value of derivatives for the four commercial banks most affected by the rule at year-end 2011 was $193 trillion, of which about 95% were permissible derivatives within their bank units, as defined by the push-out rule.
The rule also permits grandfathering, so that any swaps executed out of the IDI through July 2013, when the rule takes effect, will be permitted to be retained in the IDI through maturity. Currently, there is little incentive to move this business out of the banks given counterparties' preference to transact with one entity and their desire to remain counterparties at the bank level. Therefore, only new swaps activity after the rule takes effect will be subject to the rule.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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