On Tuesday, the biggest players in the over-the-counter derivatives committed to overhauling and improving the infrastructure and workings of that market. The concessions were unusual for Wall Street, both in their specificity and the fact that they included a strict time-line within which the reforms had to be implemented.
On the other hand, given the recent statements by Gary Gensler, the freshly-installed chairman of the Commodity Futures Trading Commission, the proposals could be seen as a pre-emptive strike against m0re aggressive regulation.
Of just the sort outlined by Gensler in testimony before a Senate Committee on Thursday. Extracts below, emphasis FT Alphaville’s:
We must urgently enact broad reforms to regulate over-the-counter (OTC) derivatives. Such reforms must comprehensively regulate both derivative dealers and the markets in which derivatives trade. This is vitally important for the future of our economy and the welfare of the American people.
A comprehensive regulatory framework governing OTC derivative dealers and OTC derivative markets should apply to all dealers and all derivatives, no matter what type of derivative is traded or marketed. It should include interest rate swaps, currency swaps, commodity swaps, credit default swaps, and equity swaps. Further, it should apply to the dealers and derivatives no matter what type of swaps or other derivatives may be invented in the future. This framework should apply regardless of whether the derivatives are standardized or customized.
In addition to the ambitious goal of proposing, Gensler proposes regulating both derivatives dealers and the markets themselves, ” including regulated exchanges, electronic trading systems and clearing houses.”
Only with these two complementary regimes will we ensure that federal regulators have full authority to bring transparency to the OTC derivatives world and to prevent fraud, manipulation, other types of market abuses, as well as to impose position limits to prevent the burdens of excessive speculation. These two regimes should apply no matter which type of firm, method of trading or type of derivative or swap is involved.
Nor did he neglect counterparty risk:
In addition, regulations should cover any other firms whose activities in these markets can create large exposures to counterparties.
Back to dealers:
Specifically, all derivative dealers should be subject to capital requirements, initial margining requirements, business conduct rules and reporting and recordkeeping requirements. Standards that already apply to some dealers, such as banking entities, should be strengthened and made consistent, regardless of the legal entity where the trading takes place.
Unsuprisingly, Gensler also called for central clearing, exchange trading and position limits. Regarding the latter, he argued:
Position limits must be applied consistently across all markets, across all trading platforms, and exemptions to them must be limited and well defined. The CFTC should have the ability to impose position limits, including aggregate limits, on all persons trading OTC derivatives that perform or affect a significant price discovery function with respect to regulated markets. Such position limit authority should clearly empower the CFTC to establish aggregate position limits across markets in order to ensure that traders are not able to avoid position limits in a market by moving to a related exchange or market
He also proposed a way of regulating derivatives that were too non-standard to be moved onto an exchange or cleared centrally:
Regulations should also ensure that customized derivatives are not used solely as a means to avoid the clearing requirement. We will accomplish this in two ways. First, regulators should be given full authority to prevent fraud, manipulation and other abuses and to impose recordkeeping and transparency requirements with respect to the trading of all swaps, including customized swaps. Second, we must ensure that dealers and traders cannot change just a few minor terms of a standardized swap to avoid clearing and the added transparency of exchanges and electronic trading systems.
These are significant, game-changing proposals, and while not dissimilar from those outlined by the Treasury in May, they are much more ambitious. They will not go unchallenged.
Related links:
Exchanges warn on OTC clearing – FT
Tensions rise over clearing for derivatives – FT