By Zachary A. Goldfarb
Washington Post Staff Writer
Tuesday, June 23, 2009
As Congress prepares to debate new rules for governing financial markets, federal regulators are taking steps to keep their turf wars from getting in the way of regulation.
The two agencies responsible for overseeing financial trading have reached broad agreement over how, for the first time, to regulate the vast market in derivatives -- complex investments that last year magnified the problems spreading among financial firms.
At a congressional hearing yesterday, Securities and Exchange Commission Chairman Mary L. Schapiro proposed that her agency oversee derivatives linked to stocks, bonds and securities and that the Commodity Futures Trading Commission oversee all other derivatives. CFTC Chairman Gary Gensler, sitting beside her, didn't offer his own proposal, but a spokesman said Gensler agrees with Schapiro, except on one outstanding issue.
The multitrillion-dollar derivatives market, which currently isn't regulated, enables financial firms to speculate on whether stocks, bonds, currencies and natural resources, among other things, will rise or fall in value. A particular type of derivative called a credit-default swap exacerbated the financial crisis and contributed to the collapse of American International Group, which made bets on derivatives it could not afford. Credit-default swaps, which are linked to the value of bonds, would be overseen by the SEC under the proposed agreement.
The accord between the SEC and CFTC awaits action by Congress, which a decade ago exempted derivatives from regulation. In a plan for retooling financial regulation announced last week, the Obama administration proposed new rules and heightened oversight for derivatives and the firms that trade in them. But the administration left the division of labor up to the SEC and CFTC, both independent agencies.
In the past, the two agencies have clashed over which body had the best claim to oversee this market. The Obama administration had discussed a proposal to merge the two agencies but backed off the idea in part because of opposition on Capitol Hill, where different committees have jurisdiction over the SEC and CFTC.
The derivatives market, valued at more than $400 trillion, is important both because so many financial firms participate in it and because the trading can affect the underlying assets. For example, trading in a credit-default swap linked to a corporate bond can influence the interest rate a company has to pay to borrow money.
Schapiro, Gensler and others testified before the securities, insurance and investment subcommittee of the Senate Banking Committee. Still being negotiated between the SEC and CFTC is oversight of derivatives linked to indexes -- for instance speculating on whether the Dow Jones industrial average will rise or fall.
At the hearing, Gensler pushed for more aggressive regulation than the Obama administration has requested.
Obama's proposal calls for derivatives to be traded through "central clearinghouses," which would collect data about the market and require that buyers and sellers allocate enough money to cover any trades.
Gensler wants to go a step further and require that derivatives be traded on electronic exchanges, just as stocks are traded on the New York Stock Exchange and the Nasdaq. A derivatives exchange would offer the advantages of a clearinghouse but also provide public information about the pricing and volume of trades.
Non-standard derivatives would be exempt from much of this regulation. These are derivatives linked to highly complex investments, such as securities composed of mortgages and other kinds of debt. But Gensler and Schapiro said it would be important to be vigilant about policing this market.