Sens. Carl Levin (D-MI) and Susan Collins (R-ME) last Monday introduced bipartisan legislation to give federal financial regulators immediate authority to regulate trillions of dollars in swap transactions that continue to be marketed and traded in the United States under the radar of government oversight.

The bill, The Authorizing the Regulation of Swaps Act, would repeal more than a dozen provisions in existing law, including in the Commodity Futures Modernization Act of 2000, which prohibit federal financial regulators from regulating swap agreements. It would give federal financial regulators — of banks, securities and commodities — the authority to oversee and regulate all types of swap agreements, including credit default, commodity, equity, interest rate and foreign currency swaps. The authority to regulate would apply to all exchange-traded and over-the-counter (OTC) swap agreements, without exception.

The legislation, however, does not require federal regulators to regulate swap agreements — it merely gives them the authority for such regulation and removes the statutory barriers in place since 2000. Nor does the bill provide any direction to federal regulators on how to regulate swaps other than to require them to consult, work and cooperate with each other to promote consistency in the treatment of swap agreements.

By removing existing statutory prohibitions, the bill gives regulators immediate interim authority over the multi-trillion-dollar swaps markets and clears the way for more specific swaps requirements in subsequent comprehensive financial reform legislation later this year, according to Levin and Collins.

Swaps typically are an agreement between two parties placing a bet on future cash flows. Some swaps bet on whether stock price, interest rate, commodity price or currency value will rise or fall; others bet on whether a company will default on payment of a bond. Stock price bets are referred to as equity swaps; bets on whether companies will pay their debts are referred to as credit default swaps (CDS).

As of June of last year the Bank of International Settlements estimated that the worldwide swaps markets included CDS transactions with a total notional value of $57 trillion; commodity swaps with a notional value of $13 trillion; equity swaps with a notional value of $10 trillion; foreign currency swaps with a notional value of $62 trillion; and interest rate swaps with a notional value of $458 trillion.

“Hundreds of billions of taxpayer dollars have already been spent on AIG [American International Group] and others that got in over their head on swaps while regulators’ hands were tied,” Levin said.

“Our legislation would take the first step to reduce risk by removing statutory barriers and giving federal regulators clear authority to put a cop on the beat in [the] swaps markets,” he said. Levin noted that Congress needs to take this action now “without waiting for a comprehensive financial reform bill later this year.”

The legislation “is a critical component of the overall reform needed to restore confidence in our financial regulatory system,” echoed Collins. “While local credit unions and small community banks are subject to safety-and-soundness regulation, enormous Wall Street financial institutions that have a far greater impact on our economy have not been subject to such regulation.”

The Obama administration also is looking at the issue of regulation of swaps and other financial instruments. In March Treasury Secretary Timothy Geithner proposed a major expansion of federal regulatory authority over large financial firms and markets that he said pose systemic risks to the economy (see NGI, March 30). He called for comprehensive regulatory reform, “not modest repairs at the margin, but new rules of the game” that are “simpler and more effectively enforced and produce a more stable system.”

Testifying before the House Financial Service Committee, he called for the creation of a single federal agency to have responsibility for the “consolidated supervision” of systemically important financial firms and for systemically important payment and settlement systems and activities, such as OTC derivatives, CDS transactions, hedge funds and money market mutual funds.

“We’re examining right now the question about what requires legislation and what we can do with existing authority,” Geithner told the House committee. “We actually can do quite a lot with existing authority,” but that authority is “segmented…and no one’s really accountable for looking at the whole thing.”

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