US Treasury outlines OTC regulation plan

The Obama Administration has proposed a regulatory framework for all over-the-counter (OTC) derivatives contracts.

In a letter to Senate Majority Leader Harry Reid yesterday, US Treasury Secretary Timothy Geithner laid out a number of amendments to the Commodity Exchange Act (CEA, which regulates commodity futures and options trading), securities laws and other legislation relevant to the regulation of the over-the-counter (OTC) derivatives markets.

He has called for clearing of all standardised OTC derivatives through regulated central counterparties (CPPs) imposing robust margin requirements and other risk controls to ensure customised OTC deals are not used to bypass CCPs. He added that standardised transactions should be moved onto regulated exchanges.

Geithner said dealers and other parties active in the market should be subject to supervision and regulation, with conservative capital requirements, business conduct standards and reporting requirements. Initial margins on counterparty credit exposures should also be subject to certain requirements. He said this would cover counterparty risks associated with customized transactions that would not be accepted by a CCP.

The Treasury Secretary also argued that the CFTC and SEC should be able to impose recordkeeping and reporting requirements on all OTC derivatives. He said CPPs and trade repositories should also be required to make aggregate data on open positions and trading volumes public. An individual counterparty's trades and positions should also be available on a confidential basis to the CFTC, SEC and the institution's primary regulators.

In March, Geithner called for the establishment of a comprehensive regulatory framework for OTC derivatives, which are currently largely exempt from regulation. Since this time, the Treasury has been discussing the issue with the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC) and other federal regulators. In the letter to Reid, Geithner said he wanted to limit risk to the wider financial system, promote efficiency and transparency, prevent market manipulation and ensure OTC derivatives are not marketed to "unsophisticated parties".

Geithner concluded: "I look forward to working with Congress to shape US legislation implementing these measures. We will need to take care that in doing so we do not call into question the enforceability of OTC derivatives contracts. We also will need to work with authorities abroad to promote implementation of complementary measures in other jurisdictions, so that achievement of our objectives is not undermined by the movement of derivatives activity to jurisdictions without adequate regulatory safeguards."