Using derivatives to protect consumers

As Congressional negotiators near the finish line on historic legislation to overhaul the nation’s financial markets, it remains crucial they continue to be focused on what caused the upheaval in 2008 — and what did not. This is especially critical for a number of industries — and their customers — that are active participants in those markets but do not contribute meaningfully to the systemic risk that sent our financial system reeling. Electric and gas utilities are just such a sector.

From the outset, lawmakers have appropriately focused on bringing transparency to trading schemes that helped trigger the market meltdown two years ago focusing specifically on the complex web of derivatives instruments that have proliferated in recent years. But as Congressional reformers do so, I would urge them not to throw out the good with the bad.


For example, one very good use of derivatives that occurs on a daily basis in the electric and gas utility sectors, as these commercial end-users utilize over-the-counter (OTC) markets to manage commercial risk on behalf of their customers to keep energy costs stable and affordable.

If utilities are required to clear all of their contracts through exchanges, it would impose huge new costs in terms of posting margin capital requirements — costs that would be ultimately borne out in customer rates. And the timing of such an outcome would be especially onerous considering the industry has significant capital needs as it continues to invest heavily in America’s energy infrastructure — resulting in the creation of more jobs and a cleaner, more efficient and globally competitive economy.

As Congressional conferees work on ironing out the differences between the two chambers’ financial reform packages, there is much to support in this regard. Both the House and Senate measures now contain the fundamental elements of an exemption for end-users such as utilities. But to ensure that commercial end-users can rely on whatever emerges from the House-Senate conference, these entities should not be categorized as either a “swap dealer” or as a “major swap participant.”

We must always keep in mind the original intent of this legislation, which is to improve transparency, accountability and stability in the nation’s financial markets and avoid the systemic risk that caused the financial crisis. However, careful attention must be paid to the exact wording in the legislation so as to avoid unintended consequences such as job losses and higher costs to every energy consumer in the country.

Commercial end users do not pose a systemic risk to the financial markets or the U.S. banking system. In fact, the entire commodity market is less than 1 percent of the global over-the-counter (OTC) derivatives market, and the energy portion is yet a fraction of that 1 percent.   


For those reasons, I would strongly urge congressional negotiators to ensure the current definitions for swap dealer and major swap participant do not include commercial end users such as electric and gas utilities. The penalty for failing to do so would almost certainly be swift and steep for those industries — and their customers.

Including an end-user exemption in this important financial overhaul while preserving utilities’ access to the OTC derivatives markets will do nothing to compromise transparency or market stability. But it would mean everything to helping ensure affordable, stable customer rates at a time when utilities are accelerating the transition to a low-carbon, smart energy future.

Breaux is a principal at the Breaux-Lott Leadership Group. He served in the U.S. Senate from 1987 until 2005 and before that in the U.S. House from 1972 until 1987. He has lobbied Congress on this issue on behalf of his clients representing numerous business sectors, including energy.