"Two complementary regulatory regimes" will be required to prevent fraud, manipulation and other abuses in the over-the-counter (OTC) derivatives market, the head of the Commodity Futures Trading Commission (CFTC) told a Senate subcommittee Monday.
One of the regimes would be "focused on the dealers that make the markets in derivatives and one focused on the markets themselves -- including regulated exchanges, electronic trading systems and clearing houses," CFTC Chairman Gary Gensler said during a Senate Banking subcommittee hearing on modernizing the oversight of the OTC derivatives market.
Gensler appeared before Congress less than a week after President Obama called on lawmakers to give the CFTC and the Securities and Exchange Commission "unimpeded authority" to police the OTC derivatives market (see Daily GPI, June 18).
"Only with these two complementary regimes will we ensure that federal regulators will have full authority to bring transparency to the OTC derivatives world and to prevent fraud, manipulation and other types of market abuses. These two regimes should apply no matter which type of firm, method of trading or type of derivative or swap is involved," he said.
"The full, mandatory regulation of all derivatives dealers would represent a dramatic change from the current system in which dealers can operate with limited or no effective oversight."
Gensler said he believed all derivative dealers should be subject to capital requirements, initial margining requirements, business conduct rules, and reporting and recordkeeping requirements.
He called on Congress to "explicitly require" regulators to promulgate capital requirements for all derivatives dealers. "No longer would derivatives dealers or counterparties be able to amass large or highly leveraged risks outside the oversight and prudential safeguards of regulators."
To improve market transparency, all derivatives that can be moved into central clearing should be required to be cleared through regulated central clearing houses and brought onto regulated exchanges or regulated transparent electronic trading systems, Gensler noted.
As for nonstandardized products, he and other federal regulators believe that higher margin and capital requirements would be appropriate for dealers who offer such products.
This stricter regulation could "hammer the little guy," said Sen. Mike Johanns (R-NE). But Gensler argued otherwise, saying he believes "they will greatly benefit by lower risk" in the marketplace.
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