Team Obama punts again on derivatives

August 11, 2009

The Obama administration formally sent its plan for regulating derivatives to Capitol Hill today. And to no one’s surprise, the key proposal in the 115-bill is a plan to regulate “standard” derivatives on regulated exchanges of clearinghouses.

As I’ve pointed out a number of times, Team Obama has yet to come-up with a workable definition for a standard derivative. The administration seems content to kick the issue down the road.

The bill would leave it up to the discretion of the CFTC and SEC to develop a definition of a standard derivative. The agencies have up to 180 days after the law is enacted to formulate a definition.

Team Obama says the definition should be as broad as possible and says regulators should consider things like trading volume in specific transactions and whether agreements have similar terminology. Also, in a bit of circular sounding reasoning, the bill says:

A swap that is accepted for clearing by any registered derivatives clearing organization shall be presumed to be standardized.

But I’d like to have seen more leadership on this issue from the White House. Leaving it to the regulators to decide will allow an opportunity for the industry to get their hooks into this and potentially create a mess. It would have been better if Treasury took an initial stab at this by promulgating its own definition of a standard derivative.

I fear this will permit too many derivatives to be classified as non-standard contracts–something that would exempt them from being traded on an exchange.

Hopefully the congressional committess that consider this bill will propose a definition and not leave it up to the vagaries of regulatory rulemaking to craft a solution.

Here’s the relevant section on the definition of a standard derivative:

“(3) SWAPS DESIGNATED AS STANDARDIZED.—
“(A) Within 180 days of the enactment of the Over-the-Counter Derivatives Markets Act of 2009, the Commission and the Securities and Exchange Commission shall jointly adopt rules to further define the term ‘standardized.’ In adopting such rules, the Commission and the Securities and Exchange Commission shall jointly define the term ‘standardized’ as broadly as possible, after taking into account the following factors:
“(i) the extent to which any of the terms of the swap, including price, are disseminated to third parties or are referenced in other agreements, contracts, or transactions;
“(ii) the volume of transactions in the swap;
“(iii) the extent to which the terms of the swap are similar to the terms of other agreements, contracts, or transactions that are centrally cleared;
“(iv) whether any differences in the terms of the swap, compared to other agreements, contracts, or transactions that are centrally cleared, are of economic significance; and
“(v) any other factors the Commission and the Securities and 16
Exchange Commission determine to be appropriate.
“(B) The Commission may separately designate a particular swap or class of swaps as standardized, taking into account the factors enumerated in subparagraph (A)(i)-(v) and the joint rules adopted under paragraph (3)(A).

“(4) PREVENTION OF EVASION.—The Commission and the Securities and
Exchange Commission shall have authority to prescribe rules under this subsection, or issue interpretations of such rules, as necessary to prevent evasions of this Act provided that any such rules or interpretations must be issued jointly to be effective.

“(5) REQUIRED REPORTING.— Both counterparties to a swap that is not accepted for clearing by any derivatives clearing organization shall report such a swap either to a swap repository described in section 21 or, if there is no repository that would accept the swap, to the Commission pursuant to section 4r within such time period as the Commission may by rule or regulation prescribe.

3 comments

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We had a program it was called the Glass-Steagall Act and was repealed in 1999. It kept savings banks and investment banks separate. Now Obama says they cannot restore the Glass-Steagall Act because these banks have gotten “too big to separate”. What a steaming pile. We do not need more government meddling in this. We had a system that worked well since 1932. Put it back.

Posted by Pete | Report as abusive

Absolutely agree with Pete. Bell Telephone and Standard Oil weren’t too big too split up, what’s so special about banks? It’s should be easier – aren’t they supposed to operate with chinese walls between their different divisions anyway?

These banks sell off their investment banking arms to each other at the drop of a hat if it suits them – why is it suddenly impossible if a government requires them to do it?

Posted by Steve Marshall | Report as abusive

Without the separation of investment banking and saving banking, any financial companies (just like AIG and Citi) would think everything would be invested, re-invested and even rubbish can be packaged and invested. This leads some of the incapable companies to pretend that they are “smart” enough to do the investment business as well. Any eventually and nearly every time, only investors got burnt…
Thus the problem is not the investment vehicle such as derivatives but the eligible entities to do investments. This financial mess may be actually caused by some entities without the “smart” or tangled by too much “conflict of interests” to do real investment business. Just see who can survive and who die or need to be recused in this mess can figure out those respective entities.

Posted by Rose Eli | Report as abusive

[...] echoes a column from Matthew Goldstein at Reuters, who argues the White House needs to take the lead in defining [...]