Overwhelmed regulators give Wall Street a reprieve

June 10, 2011

Regulators are having such a difficult time translating into action the Wall Street overhaul Congress ordered last year that they are cutting the investment industry — and themselves — some slack.

The Securities and Exchange Commission is about to miss a deadline to impose a new system of law and order on one of Wall Street’s wildest frontiers — the vast, unregulated market in a category of derivatives known as security-based swaps.

New requirements governing the financial instruments were scheduled by law to take effect July 16, about a year after enactment of the Dodd-Frank Act. But the SEC has yet to draft some of the rules and put them out for public comment, let alone take a final vote on whether to adopt them.

For the investment industry, the state of affairs was a recipe for confusion.

As a stopgap solution, the SEC said Friday that it will provide “temporary relief” from some provisions of the new law. It said it would also offer a reprieve from some requirements that predated the new law. The agency did not spell out the specifics of its temporary solution but said it will do so soon.

The sweeping Dodd-Frank legislation was part of the government’s response to the financial crisis of 2008, which nearly plunged the nation into an economic depression. But Congress left many of the difficult decisions to regulators, who must translate the law’s broad mandates into detailed rules.

Regulators such as the SEC have been straining under the scale and complexity of the task. They also have been facing intense pressure from industry groups, which have been lobbying to shape the outcome.

The SEC has proposed or adopted measures involving about two-thirds of the rules it is required to issue, the SEC said.

“We’re trying to move forward as quickly as we can, subject to making sure we get it right,” said Robert W. Cook, director of the SEC’s Division of Trading and Markets.

Swaps are financial contracts through which parties can exchange risks and benefits. They can be used to hedge against market swings or to make speculative investments.

Unlike stocks, which are traded on exchanges where the prices are clear for all to see, security-based swaps are traded in an opaque realm. Some players can have hidden advantages over others, and it is hard for investors to know whether they are getting a fair deal.

It’s also hard for regulators to know what’s going on.

“It’s a big market out there, and we’re trying to move it into a regulated environment,” Cook said.

The SEC is trying to lay the groundwork for the swaps to be traded on an electronic platform like an exchange. It is also working on standards governing how much capital that firms dealing in swaps must hold to cushion against risk and to assure they can meet their obligations. And it is trying to determine how much money investors must put down in cash when they are trading in swaps and to what extent they can trade with borrowed money, also known as trading on margin.

One of the challenges regulators face is distinguishing between firms using swaps as part of speculative investment strategies, such as a hedge fund betting on changes in interest rates or commodity prices, and other companies using swaps to stabilize operating expenses, such as a beer company trying to protect itself from sharp fluctuations in the price of ingredients such as hops.

Businesses have argued that the government should be more accommodating of companies hedging risks related to the cost of their raw materials. But some observers worry that exceptions for those end-users could create loopholes.

Much of the rulemaking on derivatives is the job of another agency, the Commodity Futures Trading Commission.

The CFTC has scheduled a public meeting for Tuesday to discuss its timetable.

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