Financial Regulatory Forum

US SEC warns swaps may evade White House reform

By Reuters Staff
September 22, 2009

USA/ By Charles Abbott and Rachelle Younglai
WASHINGTON, Sept 22 (Reuters) – The U.S. securities regulator warned Congress on Tuesday that parts of the $450 trillion private swaps market could still fall through regulatory cracks under the Obama administration’s financial reform plan.

Securities and Exchange Commission Chairman Mary Schapiro said stricter rules were needed to prevent market participants from shopping for the weakest rules, and said regulators needed more tools to enforce anti-fraud authority.

The administration’s proposal “unfortunately does not currently provide the tools needed to adequately police all these swaps,” Schapiro told the House Agriculture Committee hearing.

Global policymakers agree that the over-the-counter derivatives market should be regulated after a type of derivative, credit default swaps, led to insurer American International Group’s near collapse and $180 billion government bailout.

However, Congress has lost some of its momentum. Agriculture Chairman Collin Peterson said on Tuesday: “I would hope there would be some way we get this wrapped up by the end of this year.”

Senator Jack Reed introduced a bill on Tuesday to regulate the derivatives market. But Senate Banking Chairman Christopher Dodd said “nothing has been written yet.”
The administration proposal would split responsibility between the SEC and the Commodity Futures Trading Commission.

The SEC would oversee derivatives based on individual securities and the CFTC would regulate derivatives that draw their value from a broader index of securities.

Schapiro said traders could exploit differences in regulation between swaps and the equity and futures markets and swaps needed to be regulated like their underlying assets.

“Congress should extend the federal securities laws to all securities-related OTC derivatives and extend the Commodity Exchange Act to all commodity-related and non-securities related OTC derivatives,” said Schapiro.

Under the administration plan, “standardized” contracts would be required to be cleared and be traded on exchanges or via a “swap execution facility.” Customized contracts would face higher margin and capital requirements.

She urged lawmakers to close the unregulated foreign bank loophole for “identified banking products.”

Last week, processors, distributors and other “end users” said they often pledge assets, but not cash, in swaps deals. It would be a costly burden, they said, to post a cash reserve, the normal procedure at clearinghouses.

CFTC Chairman Gary Gensler tried to assuage concerns that reforms would hamper the ability of commercial users to hedge their price risks.

“We can bring this market on to exchanges and clearing, while allowing energy companies to actively use these risk management contracts,” said Gensler. One approach would be for end users to develop credit arrangements with members of clearinghouses, he said.

Gensler and Peterson said more market transparency could lower the cost to end users of swaps contracts.

“When you bring this out into the open, you narrow the spreads,” said House Agriculture Committee Chairman Peterson. “That is why the big guys are fighting this, because it will cost them money. That is at the heart of this whole thing.”

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