WASHINGTON - The Wall Street Journal
Two federal regulators told lawmakers Wednesday there are some flaws in a top U.S. House lawmaker's draft proposal on over-the-counter derivatives which may allow too many large companies to escape regulations.
U.S. Commodity Futures Trading Commission Chairman Gary Gensler and Henry Hu, the director of a newly created risk division at the Securities and Exchange Commission, laid out their concerns at a House Financial Services Committee hearing Wednesday.
The derivatives proposal, drafted by U.S. House Financial Services Chairman Barney Frank (D., Mass.), differs from the Obama administration's plan in several ways. One of those differences is problematic, Mr. Hu and Mr. Gensler said, because it creates a loophole that would allow major companies that trade swaps to escape new regulations if they are using over-the-counter derivatives to manage business risks.
"The term risk management is ambiguous, and this wording could cause a large number of important entities to fall outside this needed new regulation," Mr. Hu said.
Among those key entities that could escape regulation, Mr. Gensler later added, are government-sponsored entities such as Fannie Mae and Freddie Mac -- two companies at the center of the financial crisis.
"I think this is an unintended consequence," Mr. Gensler told lawmakers. "We think it should be addressed."
Rep. Frank's draft bill contains some of the main elements of the Obama plan. It would call for moving standard contracts traded by dealer firms and major market players into clearinghouses, which guarantee trades and reduce credit risk.
It would also impose higher capital and margin charges on customized products traded off exchanges and require all derivative trades be reported to a central repository so that regulators and the public can get more information on pricing. Under the plan the SEC and CFTC would share joint authority to police the over-the-counter market.
Unlike the Obama plan, however, it would not mandate that all standard products be traded on regulated platforms. And in response to major lobbying efforts, the bill would create broader exemptions for end-users so they would not be required to clear their contracts and then post cash margin.
Despite lingering concerns about the bill's impact on businesses, many Republicans conceded Wednesday that Mr. Frank's bill appears to be a step in the right direction.
"When viewed in the context of the proposal that had been previously put forward by the administration on derivatives, Chairman Frank's discussion draft is an improvement in some respects," said Rep. Scott Garrett (R., N.J.)
Mr. Gensler and Mr. Hu said they also have some other major disagreements with the bill, but they differed on what those are and how to address them.
Two of Mr. Gensler's main concerns centered around the lack of a mandate for exchange or electronic trading and the clearing exemptions created for end-users in the bill.
"Transactions should be reported on a real time basis similar to how reporting functions in the corporate bond world work," Mr. Gensler said.
Mr. Hu, however, disagreed.
"We differ slightly from Chairman Gensler as to the mandatory exchange-trading," Mr. Hu said. "We believe that clearing requirements will get a lot of the transparency and other benefits."
Mr. Hu said the SEC is concerned the bill fails to give ample anti-fraud authority to the agency by not extending it to cover clearinghouses or repositories. Other concerns, he said, center on the jurisdictional divisions between the SEC and CFTC and the failure of the bill to regulate security-linked swaps like securities.
"The discussion draft could result in significant regulatory differences between swaps products and the currently regulated securities and futures products," Mr. Hu said. "This is significant because, in evaluating whether to engage in a swap transaction, market participants are far more likely to focus on the choice between a swap and regulated alternatives."
Rep. Frank said he hopes to have the U.S. House vote on the bill by November and ideally have the president sign it into law in December. He stressed that although the bill is a "work in progress," it still must be sensitive to the needs of end-users who only need derivatives to hedge risk and are not posing major risks to the system.
U.S. Commodity Futures Trading Commission Chairman Gary Gensler and Henry Hu, the director of a newly created risk division at the Securities and Exchange Commission, laid out their concerns at a House Financial Services Committee hearing Wednesday.
The derivatives proposal, drafted by U.S. House Financial Services Chairman Barney Frank (D., Mass.), differs from the Obama administration's plan in several ways. One of those differences is problematic, Mr. Hu and Mr. Gensler said, because it creates a loophole that would allow major companies that trade swaps to escape new regulations if they are using over-the-counter derivatives to manage business risks.
"The term risk management is ambiguous, and this wording could cause a large number of important entities to fall outside this needed new regulation," Mr. Hu said.
Among those key entities that could escape regulation, Mr. Gensler later added, are government-sponsored entities such as Fannie Mae and Freddie Mac -- two companies at the center of the financial crisis.
"I think this is an unintended consequence," Mr. Gensler told lawmakers. "We think it should be addressed."
Rep. Frank's draft bill contains some of the main elements of the Obama plan. It would call for moving standard contracts traded by dealer firms and major market players into clearinghouses, which guarantee trades and reduce credit risk.
It would also impose higher capital and margin charges on customized products traded off exchanges and require all derivative trades be reported to a central repository so that regulators and the public can get more information on pricing. Under the plan the SEC and CFTC would share joint authority to police the over-the-counter market.
Unlike the Obama plan, however, it would not mandate that all standard products be traded on regulated platforms. And in response to major lobbying efforts, the bill would create broader exemptions for end-users so they would not be required to clear their contracts and then post cash margin.
Despite lingering concerns about the bill's impact on businesses, many Republicans conceded Wednesday that Mr. Frank's bill appears to be a step in the right direction.
"When viewed in the context of the proposal that had been previously put forward by the administration on derivatives, Chairman Frank's discussion draft is an improvement in some respects," said Rep. Scott Garrett (R., N.J.)
Mr. Gensler and Mr. Hu said they also have some other major disagreements with the bill, but they differed on what those are and how to address them.
Two of Mr. Gensler's main concerns centered around the lack of a mandate for exchange or electronic trading and the clearing exemptions created for end-users in the bill.
"Transactions should be reported on a real time basis similar to how reporting functions in the corporate bond world work," Mr. Gensler said.
Mr. Hu, however, disagreed.
"We differ slightly from Chairman Gensler as to the mandatory exchange-trading," Mr. Hu said. "We believe that clearing requirements will get a lot of the transparency and other benefits."
Mr. Hu said the SEC is concerned the bill fails to give ample anti-fraud authority to the agency by not extending it to cover clearinghouses or repositories. Other concerns, he said, center on the jurisdictional divisions between the SEC and CFTC and the failure of the bill to regulate security-linked swaps like securities.
"The discussion draft could result in significant regulatory differences between swaps products and the currently regulated securities and futures products," Mr. Hu said. "This is significant because, in evaluating whether to engage in a swap transaction, market participants are far more likely to focus on the choice between a swap and regulated alternatives."
Rep. Frank said he hopes to have the U.S. House vote on the bill by November and ideally have the president sign it into law in December. He stressed that although the bill is a "work in progress," it still must be sensitive to the needs of end-users who only need derivatives to hedge risk and are not posing major risks to the system.
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