Treasury unveils bill to reform derivatives on OTC

The Department of the Treasury last Tuesday sent to Capitol Hill the final piece of its financial regulatory reform legislation, a 115-page bill aimed at reforming regulation of over-the-counter derivatives.
AUG 16, 2009
The Department of the Treasury last Tuesday sent to Capitol Hill the final piece of its financial regulatory reform legislation, a 115-page bill aimed at reforming regulation of over-the-counter derivatives. “These markets have largely gone unregulated since their inception,” the Treasury Department said in a statement. “Enormous risks built up in these markets, substantially out of the view or control of regulators, and these risks contributed to the collapse of major financial firms in the past year and severe stress throughout the financial system.” Under the legislation, the OTC derivative markets would be regulated in a comprehensive way for the first time. OTC derivatives dealers and other major market participants would also face regulation. Rules governing credit default swaps markets would be aimed at guarding against activities posing excessive risk to the financial system, and at preventing market manipulation, fraud, insider trading and other abuses. Regulation also would seek to ensure that OTC derivatives aren't marketed inappropriately to unsophisticated parties, including small municipalities. The legislation would require standardized OTC derivatives to be centrally cleared by a derivatives clearing organization regulated by the Commodity Futures Trading Commission or a securities clearing agency regulated by the Securities and Exchange Commission. OTC dealers and banks would be regulated by federal banking agencies. OTC derivatives dealers and market participants that aren't banks would be regulated by the CFTC and the SEC. To improve transparency and market efficiency, standardized OTC derivatives would be required to be traded on exchanges or on regulated swaps execution facilities. Customized derivatives would be subject to higher capital and margin requirements to encourage standardization, said Michael Barr, assistant secretary for financial institutions at the Treasury Department. He spoke to reporters during a telephone briefing on the legislation last week.

"BROAD DEFINITION'

“More product will be moved into the standardized space,” as the legislation would impose a broad definition of standardized products, in addition to higher capital and margin requirements for customized products, Mr. Barr said. For companies that need customized products, “we want to make sure that there's an appropriate regulatory regime, but one that doesn't stifle the marketplace,” he said. Full reporting into a trade repository would be required, along with aggregated data released to the public, and specific information would have to be reported to regulators for customized transactions, Mr. Barr said. “It is a comprehensive reform going right to the very heart of the problems that we saw in the last crisis to block any kind of future AIG problems from arising in the system,” he said, referring to American International Group Inc. of New York. E-mail Sara Hansard at [email protected].

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