The C.T. Bauer College of Business held its final spring discussion as part of the Distinguished Leaders Series on Wednesday to evaluate the Dodd-Frank Wall Street Reform and Consumer Protection Act and its implications to the energy industry and firms.
Craig Pirrong | Justin/The Daily Cougar
The DSL is sponsored by AGL Resources and it serves as a forum to connect students with professionals, most recently with those who are in leadership positions in the energy industry.
Craig Pirrong, finance professor and director of Energy Markets at Bauer, said that the Dodd-Frank, or what he calls “FrankNDodd,” is a monster that has gotten out of control because its implications and consequences were not clear when the act was first passed.
The main reason for Dodd-Franks was to address sustained risks to try to prevent a crisis such as the Great Recession of 2008, Pirrong said. The legislation intends to subject firms to a number of regulations to protect consumers from abusive lending and mortgage practices by banks.
One of the ways Dodd-Frank intended to do that is positions limits, which is the highest number of options, or futures contracts, an investor is allowed to hold on one underlying security.
“There was a fear of speculation,” Pirrong said. “The rule conceptually was going to constrain the sizes of acquisitions that speculators could hold, but it also has features that will potentially restrict the ability of hedgers to secure future pricing.”
The consequences of the act have caused firms to challenge some of its rules, Pirrong said. An example is Bloomberg LP’s lawsuit against the commission because the rules prevent the company from operating a swap-execution facility.
“Dodd-Franks made (swap-execution facilities) over the counter, like in an exchange market,” Pirrong said. “This is just one example of a rule that is being challenged. It’s possible that other rules are going to be challenged as well.”
“It is inevitable as we move forward to find things that don’t work and problems that weren’t anticipated.”
The swap push-out provision is another unique aspect of Dodd-Frank. The law requires energy and commodity swaps had to be put under and be executed under a separately capitalized subsidiary of a bank, Pirrong said.
The law also deals with the issue of collateral margining. In transactions like forward, futures or option, the people involved are essentially buying derivatives and promising to pay for them. But there is always the risk that one of the parties will no be able to keep that promise. So trades are sometimes collateralized to address that risk.
“One of the things in Dodd-Frank is that the more collateralized the better,” Pirrong said. “This means that there’s tremendous need for clearing in order to support trading transactions. This is particularly burdensome for firms and industries like energy because they are not businesses that hold great amount of liquid assets. You have to come up with additional cash to be able to maintain your collateralism.”
This will probably reduce the liquidity of the market and make it more expensive for participants. This means that this rule is likely to be questioned in the future.
“It is a complicated law that is likely to have severe consequence in the liquidity of the market,” he said.
Risk and Control Senior Manager of AGL Resources Katherine Torres gave continuity to the discussion by explaining how her company prepared for the Commodity Futures Trading Commission’s Dodd-Frank regulations.
Torres said that the CFTC was created by Congress in 1974 to enable futures markets to provide an answer for price discovery, and that its power has been expanded by Dodd-Frank as a result of 2008’s crisis.
The Dodd-Frank’s rules that primarily impact the energy industry are: entity determination, position limits and record keeping and real-time reporting, Torres said.
There are several key players interpreting the rule, which causes a lot of ambiguity. She said that the uncertainty that the law has brought is a big part of the problem. An example she used is how end-users are at the mercy of what Swap Data Repositories ask them to do.
“There is a lot of unpremeditated consequences, and I think we’ll continue to see that throughout the implementation of Dodd-Frank,” Torres said. “This is what we are up against every day. This is constantly changing, and tomorrow will be something new again. I’m sure.”
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