U.S. agencies unveil crackdown on OTC derivatives

July 22, 2009

By Kevin Drawbaugh and Christopher Doering h
WASHINGTON, July 22 (Reuters) – Over-the-counter derivatives markets, a “dark corner” of the U.S. financial system, would face much greater public and government scrutiny under proposals detailed by regulators on Wednesday.

As part of the Obama administration’s broad push to reshape financial regulation, the chairmen of the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission outlined an OTC derivatives crackdown.

In addition, Deputy Treasury Secretary Neal Wolin said in a speech that next week the Treasury will deliver draft legislation to regulate over-the-counter derivatives.

CFTC Chairman Gary Gensler told the House Financial Services Committee in a hearing that all derivatives dealers should face rules regarding capital, margin, conduct and record keeping.
He urged changes in bankruptcy law to protect against derivatives dealer insolvencies and pressed for position limits for CFTC-regulated OTC derivatives that affect price discovery.

“The current financial crisis has taught us that the derivatives trading activities of a single firm can threaten the entire financial system and that all such firms should be subject to robust federal regulation,” Gensler said.

Capital requirements for derivatives dealers would help prevent systemic risk to the U.S. economy such as last year’s crisis at bailed-out insurance behemoth American International Group <AIG.N>.
Derivatives dealers should be subject to record-keeping and reporting requirements for all of their OTC derivatives positions and transactions, he said.

“These requirements should include retaining a complete audit trail and mandated reporting of any trades that are not centrally cleared to a regulated trade repository,” Gensler said.

Representative Paul Kanjorski, a Democrat from Pennsylvania and a senior member of the committee, said at the hearing that the views of the CFTC’s Gensler and SEC Chairman Mary Schapiro would help Congress “to sensibly regulate this dark corner of our financial markets.”

The Obama administration has directed the SEC and CFTC to iron out their opposing philosophies in favor of common rules making it easier to find violators and introduce new financial instruments. The two agencies, which have planned a series of public hearings on the matter in the coming weeks, have a Sept. 30 deadline.

But they did not rule out asking for an extension.

Schapiro largely echoed Gensler’s concerns about OTC derivatives. She also weighed in on another aspect of the administration’s plan, saying that any new systemic risk regulator should be backed up by a strong council of regulators empowered to set liquidity and capital standards.

A focus of the administration’s regulatory reform plan centers on having standardized over-the counter derivatives go through central clearinghouses. Problems with derivatives such as credit default swaps were blamed for amplifying last fall’s economic crisis.

Despite some lawmakers’ concerns, Gensler was confident that clearinghouses would lower risk.
“Regulators would be able to see (the clearinghouses) and rigorously oversee them,” Gensler said. “I believe over time you might see a consolidation and a concentration in this, but initially the statute would allow for more than one.”

Representative Judy Biggert, an Illinois Republican and House Financial Services Committee member whose district includes affluent Chicago suburbs, said she was concerned that a crackdown could harm financial markets’ ability to innovate.

“It’s crucial that we strike the right balance and not overreact,” she said.

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