12 August 2009
Published in: Risk governance, Investment risk, Market risks, Regulation - supervision
US derivatives clampdown proceeds
The US administration yesterday sent Congress its proposal for legislation under which the OTC derivative markets will be comprehensively regulated for the first time. The US Treasury commented: "The legislation will provide for regulation and transparency for all OTC derivative transactions; strong prudential and business conduct regulation of all OTC derivative dealers and other major participants in the OTC derivative markets; and improved regulatory and enforcement tools to prevent manipulation, fraud, and other abuses in these markets."
Singling out credit default swaps (CDS) among other OTC derivatives, the Treasury noted: "These markets have largely gone unregulated since their inception. Enormous risks built up in these markets - substantially out of the view or control of regulators - and these risks contributed to the collapse of major financial firms in the past year and severe stress throughout the financial system."
However, as Eraj Shirvani, chairman of the International Swaps and Derivatives Association and head of fixed income EMEA at Credit Suisse pointed out in relation to the launch of ISDA's new website for CDS, "Credit default swaps continue to play an important role in today's global economy." (see related news today, "ISDA launches CDS marketplace website").
The administration hopes that Congress will "pass a comprehensive regulatory reform bill by the end of the year."
The key proposals:
Require central clearing and trading of standardized OTC derivatives:
- To reduce risks to financial stability that arise from the web of bilateral connections among major financial institutions, the legislation will require standardized OTC derivatives to be centrally cleared by a derivatives-clearing organization regulated by the CFTC or a securities-clearing agency regulated by the SEC.
- To improve transparency and price discovery, standardized OTC derivatives will be required to be traded on a CFTC- or SEC-regulated exchange or a CFTC- or SEC-regulated alternative swap execution facility.
Move more OTC derivatives into central clearing and exchange trading:
- Through higher capital requirements and higher margin requirements for non-standardized derivatives, the legislation will encourage substantially greater use of standardized derivatives and thereby will facilitate substantial migration of OTC derivatives onto central clearing houses and exchanges.
- The legislation proposes a broad definition of a standardized OTC derivative that will be capable of evolving with the markets.
- An OTC derivative that is accepted for clearing by any regulated central clearinghouse will be presumed to be standardized.
- The CFTC and SEC will be given clear authority to prevent attempts by market participants to use spurious customization to avoid central clearing and exchange trading.
Require transparency for all OTC derivative markets:
- All relevant federal financial regulatory agencies will have access on a confidential basis to the OTC derivative transactions and related open positions of individual market participants.
- In addition, the public will have access to aggregated data on open positions and trading volumes.
Extend the scope of regulation to cover all OTC derivative dealers and other major participants in the OTC derivative markets:
- Legislation will require, for the first time, the federal supervision and regulation of any firm that deals in OTC derivatives and any other firm that takes large positions in OTC derivatives.
Bring robust and comprehensive prudential regulation to all OTC derivative dealers and other major participants in the OTC derivative markets:
- Under the legislation, OTC derivative dealers and major market participants that are banks will be regulated by the federal banking agencies. OTC derivative dealers and major market participants that are not banks will be regulated by the CFTC or SEC.
- The federal banking agencies, CFTC, and SEC will be required to provide robust and comprehensive prudential supervision and regulation - including strict capital and margin requirements - for all OTC derivative dealers and major market participants.
- The CFTC and SEC will be required to issue and enforce strong business conduct, reporting, and record-keeping (including audit trail) rules for all OTC derivative dealers and major market participants.
Provide the CFTC and SEC with the tools and information necessary to prevent manipulation, fraud and abuse:
- The legislation gives the CFTC and SEC clear, unimpeded authority to deter market manipulation, fraud, insider trading, and other abuses in the OTC derivative markets.
- The CFTC and SEC will be given the authority to set position limits and large trader reporting requirements for OTC derivatives that perform or affect a significant price discovery function with respect to regulated markets.
- The full regulatory transparency that the legislation will bring to the OTC derivative markets will assist regulators in detecting and deterring manipulation, fraud, insider trading and other abuses.
Better protect unsophisticated investors from abuse in the OTC derivative markets:
- The legislation will tighten the definition of eligible investors that are able to engage in OTC derivative transactions to better protect individuals and small municipalities.