Legislators and Industry Players Struggle to Find Common Ground on Credit Swaps
February 16, 2009
"You can't eat credit derivatives," said Rep. Collin Peterson, chairman of the House Agriculture Committee. It was one of several memorable utterances at two tense hearings earlier this month, as key industry players and legislators sought to build consensus on the future of credit default swaps (CDS).
Peterson, D-Minn., who last week introduced the Derivatives Markets Transparency and Accountability Act, was paraphrasing an earlier statement--with which he disagreed--by Rep. Barney Frank, chairman of the House Financial Services Committee. Frank, D-Mass., asserted that oversight of financial--non-agricultural--over-the-counter derivatives should fall to committees and agencies with greater expertise in such contracts.
Peterson's committee is seeking to retain jurisdiction over the derivatives and wants the Commodity Futures Trading Commission to act as regulator for the sector. But the Securities and Exchange Commission has asked Congress for oversight and called for CDS to be classified as securities--a request the Senate Banking Committee has yet to comment on.
Whether the Banking Committee chairman, Sen. Christopher Dodd, D-Conn., will push for the SEC to become the instruments' primary regulator is unclear. The agency has faced stinging criticism for its handling of the credit crisis and its enforcement capabilities. Some observers see the SEC playing a role in CDS auditing, perhaps by gaining control over reporting regimes, while the Federal Reserve monitors clearing and overall risk.
Others prefer a single entity. "I think it's critical that we have one regulator and that that regulator, regardless of its name, uses a principles-based regulatory approach ... as the CFTC does today," Chris Concannon, EVP of transaction services at Nasdaq OMX Group, told the Agriculture Committee Feb. 4.
Systemic Regulator
Rather than have the SEC and CFTC battle for the oversight role, Frank has said that a new systemic risk regulator should handle credit derivatives. The Treasury Department last year proposed that systemically important entities, including the OTC derivatives payment and settlement infrastructure, be supervised by a risk regulator. Treasury recommended that the Fed take on the role, a suggestion that the industry has largely supported.
The Office of the Comptroller of the Currency and the Fed Board of Governors "have plenary authority to identify those circumstances in which clearing is appropriate and to require such clearing," said Edward Rosen, a partner at Cleary Gottlieb Steen & Hamilton, in written testimony submitted on behalf of the Securities Industry & Financial Markets Association. During questioning, Rosen was asked whether regulators should have the authority to give clearing exemptions for non-standard OTC derivatives. The CFTC, he answered, doesn't have the information "to even begin to make that determination."
The CFTC is "not the supervisor of the major global banks that do this," said Rosen. "That's not their job." A more effective approach, he said, would be to have the Fed, as supervisor of the market's largest participants, determine whether firms are appropriately clearing their transactions. For trades that are not cleared, Rosen said, "what ought to be the implications? What are the capital requirements that should be imposed for incremental risks that are created by having a large book of customized OTC transactions that are not subject to the disciplines and multilateral netting benefits of being in a clearing system?"
Rosen added that "the industry has been working with the Federal Reserve since 2005 on various voluntary initiatives to reduce risk and improve the infrastructure of the CDS market, including the development of a CDS clearinghouse."
