PWIPC (Persistent Well-Informed Private Citizen) To CFTC: "Deny SFIG Request for Margin Exemption for ABS Swaps"
My email exchange with CFTC Secretary Kirkpatrick and other CFTC staffers of 17 July 2017 to 3 August 2017.
The four emails (three from me and from Secretary Kirkpatrick) are in reverse chronological order below.
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From: Bill Harrington <[email protected]>
To: "Kirkpatrick, Chris" <[email protected]>
Cc: "Smith, Thomas J." <[email protected]>; "Fisanich, Frank" <[email protected]>; "Bauer, Jennifer" <[email protected]>; "Beale, Joshua" <[email protected]>; "Martinez, Rafael" <[email protected]>; "Schlichting, Paul" <[email protected]>; "McPhail, Lihong" <[email protected]>; "Flaherty, Eileen" <[email protected]>; Gretchen Morgenson <[email protected]>; "[email protected]" <[email protected]>; "[email protected]" <[email protected]>; "[email protected]" <[email protected]>; "[email protected]" <[email protected]>
Sent: Thursday, August 3, 2017 7:49 PM
Subject: Re: NO! to SFIG Request for No-Action Relief for Securitization Vehicles from Variation Margin Compliance
Dear Secretary Kirkpatrick,
Please forward my request to the offices of Commissioners Quintenz and Benham. Please also respond by email letting me know that you have done so.
I note that staff of the CFTC and the prudential regulators discussed the SFIG request for a no-action letter with SFIG staff and members yesterday.
Best regards,
Bill Harrington
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From: Bill Harrington <[email protected]>
To: "Kirkpatrick, Chris" <[email protected]>; "[email protected]" <[email protected]>
Cc: "Smith, Thomas J." <[email protected]>; "Fisanich, Frank" <[email protected]>; "Bauer, Jennifer" <[email protected]>; "Beale, Joshua" <[email protected]>; "Martinez, Rafael" <[email protected]>; "Schlichting, Paul" <[email protected]>; "McPhail, Lihong" <[email protected]>; "Flaherty, Eileen" <[email protected]>; "[email protected]" <[email protected]>; "[email protected]" <[email protected]>; "[email protected]" <[email protected]>; Gretchen Morgenson <[email protected]>
Sent: Thursday, July 20, 2017 11:59 AM
Subject: Re: NO! to SFIG Request for No-Action Relief for Securitization Vehicles from Variation Margin Compliance
Dear Mr. Kirkpatrick:
Thank you for your reply. Unfortunately, you have not responded to a key aspect of my request.
I requested a meeting with "all CFTC staff who have had discussions with SFIG staff and members regarding an unmargined, uncleared swap with RAC provisions and a flip clause" in 2017.
My tally of these CFTC staff — i.e., those copied here — may be incomplete.
Accordingly, please provide me with the name and email of each remaining member of CFTC staff who had one or more "discussions with SFIG staff and members regarding an unmargined, uncleared swap with RAC provisions and a flip clause" in 2017.
Alternatively, please confirm that "all CFTC staff who have had discussions with SFIG staff and members regarding an unmargined, uncleared swap with RAC provisions and a flip clause" in 2017 are copied here.
Your reply will enable me to contact "all CFTC staff who have had discussions with SFIG staff and members regarding an unmargined, uncleared swap with RAC provisions and a flip clause" in 2017 and request that they meet with me.
I want to offer practical insights regarding the implementation of the CFTC rule regarding margin posting against an uncleared swap with RAC provisions and a flip clause just as I offered practical insights during the rule making progress.
Please see the citations of my insights in the final rule and on cftc.gov.
Fixing our country requires experts on all subjects to offer insights from their respective fields at every step of a rule making process, including implementation.
These steps generally include a regulator such as the CFTC publishing an initial rule proposal that invites public comment, discussing feedback with third party entities and subject matter experts, reviewing all feedback, adopting a final rule and implementing it.
The CFTC for its part must follow the best practice of considering input from a subject matter expert on margin posting against an uncleared swap with RAC provisions and a flip clause in implementing the final rule. Otherwise, the implementation will be capricious, random and arbitrary and thus subject to legal challenge.
After all, the US operates by the rule of law and not by the whim of an individual or individuals.
Lisa Friedman described this implication in her New York Times article ‘Court Blocks E.P.A. Effort to Suspend Obama-Era Methane Rule’ of 3 July.
“[A] federal appeals court ruled…that the [E.P.A.] cannot suspend an Obama-era rule to restrict methane emissions from new oil and gas wells.”
“The judges said that the agency had the right to reverse the methane regulations but would have to undertake a new rule-making process to undo the Obama administration’s regulation [italics added]."
Best regards,
Bill Harrington 917-680-1465
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From: "Kirkpatrick, Chris" <[email protected]>
To: Bill Harrington <[email protected]>
Cc: "Smith, Thomas J." <[email protected]>; "Fisanich, Frank" <[email protected]>; "Bauer, Jennifer" <[email protected]>; "Beale, Joshua" <[email protected]>; "Martinez, Rafael" <[email protected]>; "Schlichting, Paul" <[email protected]>; "McPhail, Lihong" <[email protected]>; "Flaherty, Eileen" <[email protected]>
Sent: Monday, July 17, 2017 12:41 PM
Subject: RE: NO! to SFIG Request for No-Action Relief for Securitization Vehicles from Variation Margin Compliance
Dear Mr. Harrington,
This confirms receipt by the CFTC of your email submission, below. Your submission has been forwarded to the Offices of Acting Chairman Giancarlo and Commissioner Bowen, respectively. I see that your email was also sent to the Director and several staff members of the Division of Swap Dealer and Intermediary Oversight (DSIO). As they are now also in receipt of your correspondence, I must defer to them regarding your request for a meeting.
Sincerely,
Christopher Kirkpatrick
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From: Bill Harrington <[email protected]>
To: Chris Kirkpatrick <[email protected]>; Thomas J. Smith <[email protected]>; Frank Fisanich <[email protected]>; "[email protected]" <[email protected]>; "[email protected]" <[email protected]>; Rafael Martinez <[email protected]>; Paul Schlichting <[email protected]>; Lihong McPhail <[email protected]>; "[email protected]" <[email protected]>
Cc: Gretchen Morgenson <[email protected]>; "[email protected]" <[email protected]>; "[email protected]" <[email protected]>; "[email protected]" <[email protected]>
Sent: Monday, July 17, 2017 12:13 AM
Subject: NO! to SFIG Request for No-Action Relief for Securitization Vehicles from Variation Margin Compliance
Dear Mr. Kirkpatrick:
My name is Bill Harrington. I am a private US citizen and am writing to ask that you schedule a meeting with CFTC staff and me.
I will discuss the benefits of margin posting against an uncleared swap with RAC provisions and a flip clause. These benefits accrue to the US financial system and economy as a whole and to each provider of an uncleared swap with RAC provisions and a flip clause.
The benefits of margin posting against an uncleared swap with RAC provisions and a flip clause also accrue to the entire securitization sector—the only sector to use this type of swap.
Without margin posting, the securitization sector cannot come clean and mature into a sector that helps grow the US economy rather than harms the country by causing financial crises and bailouts.
Remember! An unmargined, uncleared swap with RAC provisions and a flip clause was the gateway component of the gateway securitizations (CDOs, CDS and RMBS) that caused the financial crisis.
Margin posting will shut down the gateway swap component for good.
This is long overdue! Without the gateway swap component, the gateway securitizations could not have been issued in the first place and the financial crisis might never have occurred.
Simply put, margin posting against an uncleared swap with RAC provisions and a flip clause is a win-win-win-win-win best practice and simple common sense.
Only industry lobbyists such as SFIG—an algae bloom that flourishes in the fetid DC swamp—and rating agencies lost when the CFTC and the prudential regulators adopted the parallel sets of swap margin rules in late 2015.
Accordingly, the CFTC must keep 1 September 2017 as the compliance deadline for the daily exchange of variation margin against an uncleared swap with RAC provisions and a flip clause.
2017 At Bats at CFTC Field: SFIG = 6/Bill Harrington = 0
I would like to meet with all CFTC staff who have had discussions with SFIG staff and members regarding an unmargined, uncleared swap with RAC provisions and a flip clause.
You may identify many of these CFTC staff using the SFIG request for no-action relief from variation margin compliance of 11 July 2017. See 'Recent History' of the SFIG request, page 2. For instance, SFIG staff and members met with CFTC Division of Swap Intermediary Oversight (DSIO) staffers Tom Smith, Frank Fisanich and Rafael Martinez on 31 January 2017.
Most recently, SFIG staff and members lobbied DSIO staff regarding the request for no-action relief of 11 July 2017 two days later on 13 July 2017, according to the SFIG News of the same date.
I did meet with DSIO staff to describe the systemic, sector and entity-level benefits of margin posting against an uncleared swap with RAC provisions and a flip clause—in 2015! These DSIO staff included Messrs. Smith, Fisanich and Martinez.
Mr. Martinez posted a summary of one such meeting, a joint intake call on 12 May 2015 that I led with the six respective teams of the CFTC and the five prudential regulators that drafted the two parallel sets of swap margin rules.
The CFTC takeaway? Mr. Harrington and his colleague "believe ABS issuers’ current practice for dealing with counterparty credit risk [an unmargined, uncleared swap with RAC provisions and a flip clause] is inadequate by construction and presents a systemic risk.”
Mr. Martinez denied my repeated requests to meet again with him, Mr. Smith, Mr. Fisanich and other DSIO staff in 2016.
My email correspondence with Mr. Martinez and the CFTC Office of Inspector General on this matter is included in my submission to the CFTC and OMB 'Capital Requirements for Swap Dealers and Major Swap Participants' of 4 May 2017. See Appendix C (pages 137-143) and also pages 16-20, which detail aspects of Appendix C.
Other of my communications with CFTC staff, including yourself, may also be found in my CFTC/OMB submission. As examples, see: footnote 5 (page 5); the description of Appendix D (pages 20-21); and Appendix D (pages 144-167).
SFIG Will Offer the CFTC Any Line in Pushing Gateway Swaps!
My submission to the CFTC/OMB also lists and rebuts the very many serious misrepresentations that SFIG staff and members have made to DSIO staff regarding the characteristics of an unmargined, uncleared swap with RAC provisions and a flip clause. See pages 40-53 of my CFTC/OMB submission.
SFIG staff and members continue to make serious misrepresentations regarding the characteristics of an unmargined, uncleared swap with RAC provisions and a flip clause not only to DSIO staff but also to Acting Chair Giancarlo and to Commissioner Bowen.
Three SFIG lines fall outside the overly generous characterization of misrepresentation.(A parenthetical correction follows each italicized line.)
- Both the CFTC and the prudential regulators excluded legacy swaps in the respective swap margin rules.(In fact, the CFTC and the prudential regulators each defined a legacy swap that was amended in any manner at all as a new swap subject to the respective swap margin rules. No exceptions.)
- A replacement market of highly-rated swap providers for legacy unmargined, uncleared swaps with RAC provisions and flip clauses exists. (Rating agency data and RAC letters demonstrate that the pre-crisis rating and risk management assumption of replacement has been a mirage since 2008. The enforceability of a flip clause, if upheld, is the last and not the first nail in the replacement coffin.)
- A swap provider of an unmargined, uncleared swap with RAC provisions and a flip clause that is a swap asset enjoys security in securitization collateral 100% of the time. (The flip clause, when upheld, instantaneously transforms an uncleared swap asset with RAC provisions and a flip clause into a fixed claim of USD 0.00. The security is, like the replacement assumption, a mirage.)
Below is the pertinent language on pages 2-3 of the SFIG request for no-action relief of 11 July 2017. Each SFIG line appears in the order above and is italicized.
"While legacy transactions were intended to be excluded from the new margin requirements [italics added], life cycle events unrelated to the performance of the securitization transaction may require that a legacy transaction may have to replace the swap and/or the swap provider (i.e., a novation may be required due to the downgrade of the swap provider) [italics added]."
"We further continue to request that the CFTC, in tandem with the prudential regulators, reconsider the regulations that have resulted in some securitization SPVs being characterized as “financial end users” and therefore being subject to daily two-way margin requirements, despite the fact that swap providers in securitization transactions are fully secured in the collateral owned by the SPV [italics added]. We would be pleased to speak with you regarding this point at your convenience."
SFIG Talks Both Sides of the USD 0.00 Flip Clause Coin
A month earlier, SFIG acted to debase one of its lines—namely, that a swap provider is "fully secured in the collateral owned by the SPV"—by filing an amicus brief with respect to Lehman Bros. Special Financing, Inc. v. Bank of America, et al., Case No. 17-cv-01224 (LGS).
The SFIG brief urges the court to uphold the enforcement of flip clauses against the Lehman Brothers estate, even though the flip clauses in question instantaneously transformed each respective unmargined, uncleared swap asset of Lehman Brothers, regardless of how deeply-in-the-money, into a fixed claim of USD 0.00.
SFIG is technically correct that each claim of the Lehman Brothers estate to a fixed amount of USD 0.00 is "fully secured in the collateral owned by the SPV." Securing a fixed amount of USD 0.00 ain’t tough.
SFIG is also technically correct that Lehman Brothers staff agreed to the flip clauses in question when entering into hundreds of pre-crisis swaps with the defendants—44 CDO issuers.
However, SFIG ignores the counterfactual that few if any of these 44 CDOs obtained an opinion on waterfall enforceability that did not carve-out the flip clause.
These carve-outs demonstrated over and over again that a flip clause had dubious standing under US law. The CDO issuers and their counsel knew this from the outset but this knowledge never stopped them from adding a flip clause to an unmargined, uncleared swap with RAC provisions day in and year out.
In other words, there was always bad faith on the part of both securitization issuers and swap providers of an unmargined, uncleared swap with RAC provisions and a flip clause. Each group—and by extension 100% of players in 100% of the securitization sector—has long known that a flip clause exposes one of the two parties to losses equal to the 100% of the swap asset. Even so, neither party holds meaningful reserves against this exposure.
In short: A pox on both parties to an unmargined, uncleared swap with RAC provisions and a flip clause. This gateway swap, which does not work in practice and cannot work even in theory, can be pushed only for so long as all interested parties—including the CFTC—ignore their respective responsibilities.
This may be a key reason that SFIG would be "pleased to speak" with Acting Chair Giancarlo and Commissioner Bowen "regarding this point [the flip clause] at your convenience," i.e. in a private, off-the-record setting. Neither SFIG, nor rating agencies, nor counsel, nor any other entity can or will defend the flip clause for attribution.
Expanding on an earlier analogy, the flip clause was the gateway provision in the type of swap that was the gateway swap component of the gateway securitizations—CDOs, CDS and RMBS—that caused the financial crisis.
My CFTC/OMB submission makes this point clear. An unmargined, uncleared swap with RAC provisions and a flip clause should be consigned to the dustbin of history along with the other failed crisis-era structures.
Margin posting does the trick perfectly.
Hey CFTC: Cut Off SFIG Pushers and Cut In Bill Harrington!
I cited similar SFIG misrepresentations in an email to you of 7 May 2017 in which I requested two separate meetings with DSIO staff.
The first meeting that I asked you to schedule in my email of 7 May 2017 was to discuss margin posting against an uncleared swap with RAC provisions and a flip clause. Today's email is my second request for such a meeting.
The second meeting that I asked you to schedule in my email of 7 May 2017 was to discuss my CFTC/OMB submission of 4 May 2017.
My email of 7 May 2017 and today's email are each posted as an article on my LinkedIn profile.
The email of 7 May 2017 can be accessed with this link.
Today's email can be accessed with this [ link omitted ].
I will call Monday 17 July to schedule a meeting to discuss margin posting against an uncleared swap with RAC provisions and a flip clause. This call will be my third request for such a meeting.
If the CFTC is granting SFIG staff and members a seventh meeting in 2017—a meeting that will misinform Acting Chair Giancarlo and Commissioner Bowen no less—DSIO staff can grant one meeting to a Persistent Well-Informed Private Citizen.
Best regards,
Bill Harrington 917-680-1465
Bill Harrington has been assessing derivative contracts in the structured finance sector for 18 years, most recently at Debtwire ABS and previously at Moody’s Investors Service. He has filed evaluations of the capitalization and ratings of derivative contracts and asset-backed securities with US and European regulators and with credit rating agencies. Bill also worked as a structurer of fixed-income and FX derivative contracts at Merrill Lynch and a currency analyst at Wharton Econometrics. Bill has an MBA from The Wharton School and a BA in Economics from the University of Pennsylvania.