With conference negotiations on a financial regulatory reform bill under way, how will commercial end-users be handled in the final legislation? During today's OnPoint, Richard McMahon, executive director of finance and energy supply at the Edison Electric Institute, makes the case for including an end-user exemption in the final conference report. McMahon also explains why he believes the lack of an exemption could lead to job loss and higher energy costs.
Monica Trauzzi: Welcome to the show. I'm Monica Trauzzi. Joining me today is Richard McMahon, executive director of Finance and Energy Supply at the Edison Electric Institute. Richard, thanks for coming on the show.
Richard McMahon: Thanks for having me, Monica.
Monica Trauzzi: Richard, conference negotiations are underway on the financial regulatory reform bill and your organization is pushing for an end-user exemption to be included in the final package. Before we get into the politics of the debate, explain for everyone what the end-user exemption is.
Richard McMahon: OK, glad to do it and I will say it's not just our organization. It's really the entire energy space, all of the utilities, publicly owned, cooperatively owned, investor owned, as well as the gas industry. So it's a pretty widespread effort. The end-user exemption essentially maintains the ability of commercial end-users, such as utilities and energy companies, to continue using over-the-counter derivatives products to hedge risk and that's commodity price risk for both natural gas and electric power. Again, those are two of the more volatile commodity groups and, at the end of the day, our customers don't want to see that volatility, so these products enable us to insulate our customers from that volatility and that risk.
Monica Trauzzi: All right, so the negatives of not having this exemption in the final package are what?
Richard McMahon: Well, the significant negative is that if we were required to centrally clear or exchange trade all of our derivatives transactions, and I will say right now we exchange trade about half of our gas transactions and about a third of our electric transactions where it makes sense, but for those where it makes more sense to do the transactions over the counter, it saves our customers an awful lot of money. We've computed…we've estimated that the amount of money saved in not having to post margin with clearinghouses, for the average utility, is between $250 and $400 million per year. That's the cash flow impact of having to put margin deposits down on clearinghouses, so it's a significant number for us.
Monica Trauzzi: But wouldn't that also require us, the consumer, and also the government putting a lot of faith in you guys?
Richard McMahon: Well, I think it's not really about putting faith. I think if you look at the over-the-counter transactions these are bilateral transactions that are conducted between two parties. They do risk assessment in each other and they make a judgment based on that risk assessment about what types of margin needs to be put in place. In some cases, in our case, we may just put down a lien on a power plant. The nice part about that for us is utilities are generally very credit worthy counterparties, so that enables us not to have to tie up cash that could be used for other things, such as building out the electric grid or deploying renewable technologies and things like that. We're trying to deploy that capital in a way that's really productive. We see having to deposit margin as basically being a very unproductive use of that capital.
Monica Trauzzi: And one of the arguments against any exemption in this package is that it would undermine the overall goal to reform the marketplace. How can you assure the public that we won't be exposed to unintended consequences?
Richard McMahon: Well, I think the real goal, as I understand it, of this financial reform package is to ensure that there isn't systemic risk or to address systemic risk. The type of transactions that we're doing to actually take risk out and hedge risks do not in any way, shape, or form contribute to systemic risk. And if you look at the overall derivatives market, it's been estimated at about a $600 trillion market. The commodities piece of that market is less than 1 percent of that market. So, what we're talking about is a very small slice of the over-the-counter market and we're talking about end-users who are using these products to hedge, not to speculate. And, again, our industry and our end-user coalition, again, which includes most of the entire energy space, believes that it makes sense to put in place effective regulation. But what we want to see is the ability to continue to use over-the-counter swaps. That's an important piece of it, so we're for transparency, it's just how it's done. There's ways to achieve transparency without requiring everybody to trade on exchange.
Monica Trauzzi: And you believe we could see job losses, as well as higher energy prices as a result of not including this exemption?
Richard McMahon: Well, there's no question about that. I mean if you look from our perspective, you know, as regulated utilities, we have capital budgets set aside to invest in the smart grid, new generation, new transmission, renewable energy and so on. And, in many cases, we're talking our industry overall is about a $900 billion industry. Well, on average, if you take a $400 million cash requirement for a deposit on an exchange, that can have a pretty significant effect on a company's capital program. So, that's taking money out where it's going to be deployed in a productive way to grow the grid, to add jobs, to do those things and putting it essentially into a bank in a margin deposit. So, we believe that there would be a significant job impact to do that.
Monica Trauzzi: So, there are aspects of the Senate passed legislation that you guys like, aspects of the House legislation ...
Richard McMahon: Yes.
Monica Trauzzi: That you're in favor of. Talk about where you think the two should meet in the middle.
Richard McMahon: Well, we were very pleased to see that both the House and the Senate bill recognized the need of end-users. We felt that the House bill did a better job of incorporating this concept of systemic risk into their definitions. I don't want to dive too far into the weeds, but they define these two categories of swaps dealer, major swaps participant, both the Senate and the House bill do that. The House bill does it in a way that incorporates the concept of systemic risk and we feel that's a better way and a better approach to do it. The Senate bill also has those definitions and establishes a category of entity called a commercial end-user, which is a little bit narrower. And our concern on the Senate side is that it's possible that you could have some inadvertent miscategorizations of commercial end-users as either a swaps dealer or a major swaps participant, when, in fact what they're doing is hedging. So, we felt that the definitions in the House were a bit more cleaner in terms of making sure that you're categorized appropriately.
Monica Trauzzi: So, if this exemption is in place, is there any government oversight at all or are they ...
Richard McMahon: Oh, yeah. Absolutely. In both bills there's going to be a requirement for reporting and our industry is 100 percent behind this idea of bringing transparency and reporting the transactions. We're happy to do it. In fact, electric utilities do a lot of this reporting already with the Federal Energy Regulatory Commission. So, we're fine, as a regulated industry, with reporting our transactions. It's just we want to be able to have the option of doing both exchange-based transactions, as well as over-the-counter transactions, which we currently do.
Monica Trauzzi: Is FERC the best agency to be overseeing this?
Richard McMahon: Well, I think that FERC does oversee this, but, in addition, we understand that the way that the rules would be implemented, the CFTC would also have the ability to look at these transactions for manipulation and things like that. So, we're perfectly comfortable with having one or both regulatory agencies looking at the transactions.
Monica Trauzzi: All right, you won't weigh in on that debate.
Richard McMahon: No.
Monica Trauzzi: All right. We'll end it there. Thank you for coming on the show.
Richard McMahon: Thank you very much.
Monica Trauzzi: Thanks for watching. We'll see back here tomorrow.
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