The heads of the two most powerful House committees overseeing derivatives markets have come together on the framework for legislation that would enhance federal regulatory authority to crack down on excessive speculation in the unregulated over-the-counter (OTC) markets.
The agreement between House Financial Services Committee Chairman Barney Frank (D-MA) and House Agriculture Committee Chairman Collin Peterson (D-MN) calls for “robust oversight” of OTC derivatives dealers, exchanges and clearinghouses by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). It gives the agencies the authority to prohibit or regulate transactions that are not traded on an exchange or cleared; to set “significantly higher capital and margin charges” on transactions that are not traded on exchanges or centrally cleared; and to set position limits to curb excessive speculation.
Peterson said the agreement between the two House committees “bridges the differences between those members who want to completely eliminate the over-the-counter market and those who think that just greater transparency is all that is needed. Neither of those approaches is a real solution; what we are putting forth is.”
The aim of the resulting legislation would be to “improve the regulation of derivatives so that they continue to perform their important market function but are less likely to contribute to a kind of irresponsibility that can cause a crisis. Nobody here wants to ban them or even severely diminish them as an economic instrument,” Frank added.
This is the Financial Services Committee’s first crack at OTC regulation this year. The House Agriculture Committee voted out a bill in February requiring the clearing of OTC transactions through a CFTC-regulated facility or through a clearinghouse regulated by the SEC. The CFTC also could carry out criminal prosecution of fraud and manipulation of commodity futures markets, but only in cases where the Department of Justice decides not to take action (see NGI, Feb. 16).
A companion bill was introduced in the Senate earlier this year by Sen. Tom Harkin (D-IA), chairman of the Senate Agriculture Committee. It seeks to bring all OTC financial transactions, which currently are traded without federal oversight, onto regulated exchanges.
The House agreement, or so-called “concept paper,” proposes mandatory clearing for all OTC derivatives. “Derivatives must be cleared by an approved clearinghouse. Exchange trading on electronic trading platforms will be strongly incentivized and encouraged,” it said. Under the House legislation, both the SEC and the CFTC could prohibit or regulate transactions that are not traded on exchanges or cleared. The agreement further requires that all OTC derivatives be reported to a qualified trade repository.
The regulators also will develop margin and capital requirements that create another “strong incentive” for dealers and users of derivatives to trade them on an exchange or electronic trading platform or have them cleared whenever possible. “Significantly higher capital and margin charges will apply to non-standardized transactions that are not exchange-traded or centrally cleared. Regulators can authorize use of non-cash collateral to satisfy margin requirements,” the concept paper said.
To curb excessive speculation in markets, regulators would have the authority to impose position limits on participants in the OTC market and ban the purchase of credit protection using credit default swaps by any non-dealer that is not hedging a risk, according to the paper. At hearings last week CFTC commissioners acknowledged that they currently do not have the authority to levy position limits in the OTC market (see related story).
The House agreement also calls for U.S. regulators to coordinate with foreign regulators on harmonizing OTC derivative market regulation, including recognized international standards with respect to clearinghouses.
In addition, the legislation would create a Financial Services Oversight Council to resolve disputes between the SEC and CFTC over joint regulation of derivative products and over new products within 180 days. And it would give the two agencies enhanced enforcement authority.
The House financial services panel is expected to take up the legislation when Congress returns from its recess after Labor Day, with the the agriculture panel to follow suit.
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