The chairmen of two US House committees with commodities regulation oversight have released a concept paper describing how they would like to regulate over-the-counter (OTC) derivatives. The committees plan to start work on legislation when Congress returns from its late summer recess after Sept. 7.
“I think we have come up with a responsible approach that bridges the differences between those members who want to completely eliminate the over-the-counter market and those who think that just greater transparency is all that is needed,” said Agriculture Committee Chairman Collin C. Peterson (D-Minn.). “Neither of those approaches is a real solution; what we are putting forth is.”
Financial Services Committee Chairman Barney Frank (D-Mass.) said, “The fundamental purpose here is to improve the regulation of derivatives so that they continue to perform their important market function but are less likely to contribute to a kind of irresponsibility that can cause a crisis. Nobody here wants to ban them or even severely diminish them as an economic instrument.”
They released the document as the US Commodity Futures Trading Commission completed two of three scheduled hearings on establishing energy position limits and possible exemptions. Position limits exist for most other commodities. Members of Congress and others have said their absence in energy markets may have contributed to the run-up of crude oil prices to record levels during 2008’s first half.
Peterson and Frank’s concept paper reflected several ideas US Treasury Sec. Timothy F. Geithner expressed on July 10 when he testified before their committees about the Obama administration’s initial commodities regulatory reform proposals.
OTC derivatives
These included regulation of OTC derivative dealers, exchanges, and clearinghouses; mandatory clearing of OTC derivatives with a few exceptions; and stronger capital and margin requirements to strongly encourage dealers and customers to trade on regulated exchanges or have transactions cleared wherever possible.
The Peterson-Frank concept paper also described two possible approaches toward speculation, adding that others may be considered. The first, designed to limit speculation so it does not become excessive, would prohibit the purchase of any credit protection on a credit default swap (CDS) unless the party owns the referenced security or one or more of the securities in an index; the party has a bona fide economic interest that the contract will protect; the party is a bona fide market maker; and regulators have authority to monitor market activity and impose position limits when necessary.
The second approach, which the paper said is designed to enhance speculative position oversight, would require OTC derivatives dealers, investment advisors managing more than $100 million, and other entities that are deemed major market participants to report all short interests in CDS contracts to the appropriate regulator. To prevent abuse, regulators would have authority to impose position limits and to ban the purchase of credit protection using CDSs by any nondealer which is not hedging a risk.
Peterson and Frank also proposed in their paper protecting US financial institutions from lesser regulatory regimes in other countries by having US regulators coordinate with their foreign counterparts to harmonize OTC derivative market regulation, including establishing international standards covering clearinghouses. The US Department of the Treasury would be authorized to restrict access to the US banking system for institutions of any jurisdiction the US Treasury determines permits lower capital-related standards or promotes reckless market activity.
The concept paper suggested that members of the two committees will be asked to determine whether the US Securities and Exchange Commission, the CFTC, or both should regulate an OTC derivative dealer, exchange, or clearinghouse. A financial services oversight council would be established to resolve disputes between the two agencies within 180 days regarding authority over new products or joint regulation of derivatives products.
ICE positions
Meanwhile, the CFTC reported that it will include positions of ICE (Intercontinental Exchange) Futures Europe exchange traders of West Texas Intermediate crude oil contracts in its weekly Commitments of Traders (COT) reports. It said that the first publication of this data will be in the July 28 COT report, to be released on July 31.
US Sen. Maria Cantwell (D-Wash.), who has frequently criticized the agency for not moving to regulate foreign exchanges’ commodities trading in the US, said that the CFTC needs to do more. “It needs to realize that it is the regulator and fully regulate the dark ICE market,” she said on July 30. “Oil prices are far too high and apparently have been driven by unchecked speculation, according to the new CFTC. So I hope it will act to bring ICE into total compliance.”
