Over-the-Counter Derivatives

Overview:
OTC derivatives are important risk management tools for companies across the country and throughout the world. Companies use OTC derivatives to manage exposures to interest rate, currency exchange rate, commodity price, and other risks inherent in their businesses. Because commercial and industrial companies use derivatives in this manner, they can devote their time and attention to what they do best: producing and providing medical equipment, clothing, floor coverings, airplanes, and other goods and services.

Many financial firms use credit default swaps to manage their exposure to credit risk in an efficient and cost-effective manner, which makes loans more available and less expensive to businesses and consumers. Because credit default swaps played a role in the problems encountered by a small number of insurance companies, including American International Group (AIG), policymakers at the federal and state levels are considering what steps can be taken to reduce the risk of similar problems arising in the future.


Position:
SIFMA supports the creation of a single financial stability supervisor, a central authority with oversight in all markets and of all systemically important market participants – regardless of charter, function or unregulated status. In conjunction with the appropriate prudential regulator(s), the systemic risk regulator should be responsible for participant and product regulation and therefore have broad authority to ensure that these market participants manage their derivatives businesses in a prudent manner. SIFMA supports the use of clearing organizations for standardized transactions and reporting through data repositories for all other OTC derivative transactions. SIFMA believes that every OTC derivatives clearing organization and data repository should be subject to federal regulatory oversight, thereby ensuring that the systemic risk regulator and other federal financial regulators have access to all of the information needed to monitor OTC derivatives markets. It is important for the federal government to create a single set of regulations in order to promote clarity and accountability.


History and Status:
House of Representatives
During 2009, legislation has been introduced in the House of Representatives and the U.S. Senate to enhance regulation of OTC derivatives. In the House, Agriculture Committee Chairman Collin Peterson (D-MN) introduced H.R. 977 which would enact mandatory central clearing of OTC derivatives and suspend "naked" CDS trading. The Agriculture Committee marked up and reported H.R. 977 on February 12, 2009. Legislation introduced by Energy and Commerce Committee Chairman Henry Waxman (D-CA) and Rep. Ed Markey (D-MA), the American Clean Energy and Security Act, H.R. 2454, includes several provisions concerning the regulation of OTC derivatives. That legislation was marked up and reported by the committee on May 21, 2009 and approved by the House of Representatives on June 26, 2009.

In October 2009, both the House Financial Services Committee and the Agriculture Committee produced derivatives legislation. House Financial Services Committee Chairman Barney Frank (D-MA) and House Agriculture Committee Chairman Collin Peterson (D-MN) drafted and marked up two distinct versions of H.R. 3795. Both bills require clearing of eligible transactions and that those transactions originate on regulated exchanges. The bills differ on key definitions and other provisions, including exemptive authority granted to primary regulators.

The House of Representatives passed the Wall Street Reform and Consumer Protection Act, H.R. 4173 on December 11, 2009 by a vote of 223 to 202. The Act requires clearable swaps to be traded on an exchange or swap execution facility, but it exempts end users that use swaps to hedge commercial risks. H.R. 4173 also would allow counterparties to request the segregation of collateral. The Act limits aggregate clearinghouse ownership, among swaps dealers, to 20%. H.R. 4173 empowers regulators by requiring all swaps dealers and major swap participants to register with the Commodity Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC).

Senate
In the Senate, Agriculture Committee Chairman Tom Harkin (D-IA) introduced S. 272, which would move most OTC derivatives onto CFTC-regulated exchanges. The Agriculture Committee’s new Chairman Blanche Lincoln (D-AR) is expected to introduce new legislation in mid-December. Other bills concerned with derivatives regulation have been introduced by Senators Carl Levin (D-MI) and Susan Collins (R-ME), S. 961; and by Senator Ben Nelson (D-NE), S. 807.

In September 2009, Senator Jack Reed (D-RI) introduced the Comprehensive Derivatives Regulation Act, S. 1691, which requires standardized derivatives transactions to be cleared, but does not mandate exchange trading for cleared transactions. S. 1691 requires all OTC transactions to be reported to trade repositories, and it does not call for shared regulatory jurisdiction (SEC and CFTC). In November, Senate Banking Committee Chairman Chris Dodd released a comprehensive financial regulatory reform bill, the Restoring American Financial Stability Act, which establishes a presumption of clearing for derivatives transactions. The bill also mandates exchange trading for cleared transactions. It grants the SEC and CFTC limited authority to exempt transactions from clearing requirements.

Executive Branch
On June 17, 2009, the Treasury Department released a White Paper entitled Financial Regulatory Reform, which prescribed mandatory clearing for all standardized OTC derivatives and more stringent capital and margin requirements for market participants. In the paper, Treasury supports the Federal Reserve as regulator of “systemically important payment, clearing, and settlement systems, and activities of financial firms;” as well as the harmonization of futures and securities regulations of the CFTC and SEC. In August, the Treasury Department released draft legislation that recommends mandatory exchange trading and attempts to clarify regulatory jurisdiction over derivatives by assigning swaps and securities-based swaps to the CFTC and SEC, respectively.

States
At the state level, the National Conference of Insurance Legislators (NCOIL) has adopted model legislation that would subject credit default swaps to regulation as insurance and prohibit such transactions that are not undertaken for hedging purposes.



OTC Derivatives

For more information, please contact:
Randall Drain
rdrain@sifma.org
+1-202-962-7403

Nathaniel Emodi
nemodi@sifma.org
+1-202-962-7406


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