Not wanting to look a gift horse in the mouth, bankers might be reticent to say anything critical of the legislative compromise on derivatives.

But if they did want to unwrap all the red tape this gift horse came in, they wouldn't see many teeth anyway.

The back-and-forth over an amendment put forth by Sen. Blanche Lincoln, D-Ark., yielded a proposal that requires all the legal legwork, regulatory interpretation and compliance challenges of meaningful reform, while addressing few of the issues that proponents of a derivatives market overhaul had identified as problematic.

Under the compromise, banks will have to create separately capitalized affiliates for their swaps activities, but only if they are dealers or insured depository institutions that are classified as major swap market participants, and only if the swaps in question are pegged to assets that banks are prohibited from investing in as per the National Bank Act, or used for purposes other than hedging or risk management.

In other words, unless regulators take an unusually hard line as they make and enforce the rules that Congress has left up to them to implement, not much will change for the banks most active in derivatives, because their concentrations typically are heaviest for interest rate and currency swaps, which look to be safe to stay where they are.

But it will take time, effort and expense to sort out the hair-splitting particulars. (For example, the trading of swaps involving gold or silver can remain in banks, but swaps involving most other metals cannot.) In Lincoln's initial proposal, institutions involved in swap markets would have been ineligible for any federal assistance such as discount window lending or deposit insurance, which effectively would have forced banks to spin off all of their swaps desks. Banks had argued the measure would constrain bank credit by taking away an important hedging tool, while increasing risk by forcing derivatives trading into less-regulated institutions or countries.

"I understand the politics behind the compromise, but we almost would have been better off with all or nothing as opposed to what we ended up with," said Joel Telpner, a Jones Day lawyer who represents derivatives dealers. "To me it is potentially almost unworkable, and it puts a tremendous amount of pressure on the regulatory bodies, which are going to have to issue a large number of incredibly complicated implementation rules."

The effective date of the legislation's derivatives provisions would be years away, and banks would want to wait for guidance from regulators before mapping out detailed plans for complying with the new rules. But Telpner said banks already are exploring the implications of the proposed bill so that they can piece together a long-term vision of their businesses — and so that they can figure out which provisions to target in what he expects will be a full-court press on regulators akin to the lobbying effort that went into the legislative debate.

Though the compromise on derivatives allowed banks to make out better than they might have, the industry still has profits on the line, giving it strong motivation to push for a favorable regulatory interpretation of the rules. Analysts at KBW Inc. estimate that the derivatives provision could lower normalized earnings per share for the largest banks by 2% to 3.5%. And the rules would require a "moderate level of IT investment" by banks as they reconfigure risk management analytics and build systems for new swap affiliates or clearinghouse derivatives trades, said Steve Berez, a partner in the information technology and financial services practices at consulting firm Bain & Co.

If that sounds benign, consider the impact from other proposals, such as the Volcker Rule and the financial crisis responsibility fee, as well as reforms regarding credit cards, interchange rules and overdraft fees. All told, KBW expects reforms to drag down normalized earnings per share by at least 10% for banks, and by as much as 27% for the money center banks.

Meanwhile, industry critics who pushed for the reform of esoteric financial markets are left with a proposal that falls vastly short of their hopes. The compromise said nothing about the vast amounts of leverage that derivatives allowed financial institutions to take on. It said nothing about cordoning off activities in the market for collateralized debt obligations, which arguably were more problematic than derivatives in the latest crisis. And while taxpayers in theory would be protected from having public dollars spent on bailouts for certain swap entities owned by bank holding companies, it is the holding companies that presumably would be the ones funding the new swap affiliates as they get formed.

"It's full employment for lawyers, that's all," said a senior official at a money center bank, who spoke on the condition of anonymity. "It has no policy relevance."

Viral Acharya, a professor at New York University's Stern School of Business, said the compromise would at least allow for the easy spinoff of swaps businesses for institutions that fall into crisis. "You could see that there could be some positive things that could arise by requiring the derivatives arms to be separately capitalized," he said.

But at what price?

"There's going to be some layer of additional cost and time," said David Kaufman, a derivatives lawyer at Morrison & Foerster LLP. "As to whether it's truly going to generate a corresponding, commensurate benefit in terms of greater systemic stability and risk reduction is very much an open question in my mind."

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