Gensler said the CFTC wants to directly regulate derivatives dealers, cracking down on leverage and reducing counterparty risk through conservative capital requirements and position limits, and by pushing many contracts onto central clearing. “I think one of the great lessons of the crisis last year was that the financial system got highly leveraged and too leveraged,” he told a hearing of the Senate Committee on Agriculture, Nutrition and Forestry yesterday. The crisis had seen the US public “caught in a spider's web” of counterparty risk, he added.
“Some people say we’ve grown into a system of too big to fail, but we’ve actually grown into a system of too interconnected to fail,” said Gensler.
Under plans outlined by the CFTC, where clearing services exist for over-the-counter derivatives, they would automatically be deemed standardised, and so should be centrally cleared. “Our proposal is that anything that could get onto clearing would be presumptively standard,” he said.
This idea is largely in line with that announced by Treasury secretary Timothy Geithner last month, who suggested amending the Commodity Exchange Act (CEA) to force all standardised OTC derivatives through regulated central counterparties.
In its written testimony, the CFTC outlined a range of criteria that might be used to identify whether an OTC contract is standardised or not, including the volume of trades in a given contract; whether it shared any similarities with standard contracts; and the extent to which its pricing and terms were disseminated to third parties.
However, Gensler emphasised that even products excluded from the requirement would not escape the eye of the CFTC. It is pushing for the mandatory registration and regulation of all derivatives dealers by the regulator – something that would enable it to subject them to “prudent and conservative” capital and initial margin requirements.
“I believe we need to bring regulation to the entire OTC marketplace. We can best do that when we have a regime to regulate the dealers,” said Gensler.
Dealers would also have to comply with business-conduct rules and reporting requirements, which would include the reporting off all OTC derivatives trades to US regulators, whether or not they are centrally cleared. In the case of products traded on regulated exchanges as well as OTC markets, market participants would be forced to abide by aggregate position limits, while also ensuring timely and accurate trade confirmation, processing and valuation.
Meanwhile, the CFTC has called for information on positions across the market to be made available to the public. It is also looking for clear authority to impose reporting requirements on all exchanges and electronic trading systems.
In response to a question from the committee, Gensler suggested that if such rules had been enforced, the problems that befell AIG might never have been allowed to occur. “If these changes were in place – not just at this regulator but others – they would have had to set capital aside, and they would have had to set margin and value contracts on a daily basis,” he said.
While strengthening derivatives regulation at home, Gensler made clear his ambition to prevent US-based market participants exploiting more relaxed rules elsewhere. “We need to work with other international regulators to ensure there’s no arbitrage in going through other markets,” he said. Where regulations were different, “we must guard against those differences,” he added.
Asked whether he supported the idea of a systemic risk regulator in the US, Gensler said additional oversight of systemically important firms was “absolutely needed”, whatever legal form it took.
However, he rejected the idea of merging the CFTC with the Securities and Exchange Commission, labelling it a “merger for merger’s sake” and saying it would distract from efforts to deal with the financial crisis.
Elsewhere, Gensler was emphatic on the issue of speculation in commodity and energy markets. Alluding to the involvement of financial market participants in the previous commodity bubble, he said the CFTC would be vigilant for another hike in prices as the global economy recovers. “I’ve asked for every option to be on the table,” he claimed.
The changes the CFTC is pushing for would essentially reverse the course set by the Commodity Futures Modernization Act of 2000, which exempted OTC derivatives from the CEA and oversight by the CFTC. However, while pressing for additional responsibilities, Gensler admitted the regulator was “still sorely under-resourced”.