Full regulation of all over-the-counter derivatives will use a broad and flexible definition of 'standardised' OTC contracts while regulators will seek to crack down on end-users seeking to customise trades to escape central clearing, US Treasury secretary Timothy Geithner told Congress today.Testifying before a joint meeting of the House Financial Services Committee and the House Agriculture Committee, Geithner provided little in the way of solid progress on his plans to regulate OTC markets, but did provide supplementary detail around how the new regime would work in theory.
"The plan will provide for strong regulation and transparency for all OTC derivatives, regardless of the reference asset, and regardless of whether the derivative is customised or standardised. We will propose a broad definition of 'standardised' OTC derivatives that will be capable of evolving with the markets and will be designed to be difficult to evade," Geithner explained. "We will employ a presumption that a derivative contract that is accepted for clearing by any central counterparty is standardised. Further attributes of a standardised contract will include a high volume of transactions in the contract and the absence of economically important differences between the terms of the contract and the terms of other contracts that are centrally cleared," he added.
Geithner went on to reiterate previously announced proposals, including the requirement that all standardised derivatives contracts be cleared through a central counterparty and executed on a regulated exchange or regulated electronic trade execution system, and the utilisation of capital requirements and other measures to encourage greater use of standardised OTC derivatives and to facilitate their migration on to central clearing houses.
"We also will require that regulators carefully police any attempts by market participants to use spurious customisation to avoid central clearing and exchanges. In addition, we will raise capital and margin requirements for counterparties to all customised and non-centrally cleared OTC derivatives. Given their higher levels of risk, capital requirements for derivative contracts that are not centrally cleared must be set substantially above those for contracts that are centrally cleared," Geithner stated in his prepared testimony.
Congressmen looking for substantial new information on how the regime would operate in practice were disappointed, as Geithner fielded questions on the general intents and goals of the a centrally cleared OTC market and refused to engage in what he described as a premature discussion of nuts-and-bolts operational issues.
Some representatives took advantage of the secretary's presence to put forward their own ideas for regulatory reform, with representative Walt Minnick arguing for the consolidation of five federal financial regulators into just two.
"We should merge the Securities Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). Whether derivatives originate in a commodity, a security or neither, like weather futures, they are functionally identical and must be traded, cleared and settled subject to the same rules. Bifurcated responsibility may be made to work temporarily but is a poor long-term solution which will encourage regulatory arbitrage," Minnick claimed. "Banking regulation should be removed from an already overburdened Federal Reserve, and the Office of Thrift Supervision, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency should be combined into a single bank regulator with resolution authority for all financial institutions deemed systemically risky," he added.
Agriculture Committee chairman Colin Peterson took the opportunity to highlight the recent strong co-operation between the Agriculture and Financial Services committees, noting that "[Financial Services chairman Barney] Frank and I have come to the conclusion that we are not going to be merging the SEC and the CFTC".
Leaving both entities untouched is politically favourable to both committees, as the status quo allows both the Financial Services and Agriculture committees to retain a supervisory stake in derivatives supervision markets rather than consolidating both agencies into one and stripping one of the bodies of their oversight of the market.
The relationship between the two committees has frequently been portrayed in the media as a fraught one, involving both sides wrangling for congressional control of OTC markets, but Frank used his opening remarks to refute such interpretations.
"I begin with an apology to our friends in the media: there is no fight between these two committees [to report on]. I know that it is an easier topic to cover than the complexities of how we actually do something. I believe the besetting sin of the House of Representatives is jurisdictional fights in which our egos get in the way of public policy and I am very proud that chairman Peterson and I and other members of our committees have made very extra special efforts to avoid that [conflict]," said Frank.
See also: EC looks to move standardised OTC derivatives onto exchanges
Obama reform plans show no progress on OTC derivatives clearing
Industry opposes mandatory clearing
Geithner calls for law change to force OTC derivatives clearing
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