U.S. regulators are expected to ask Congress as early as next week to clear up a legal cloud that has hovered for years over a type of financial contract used to hedge against the risk of price changes in stocks and corporate bonds, sources say.
The recommendation has been eagerly awaited by Wall Street, where corporations increasingly use these contracts, which are one type of an array of financial instruments known as derivatives.
Specifically, the regulators will recommend that Congress formally declare that the Commodity Futures Trading Commission should not regulate these instruments, people familiar with the recommendation say.
The reason such a declaration will remove any ambiguity over the legality of these contracts--and therefore their enforceability--is as complex as the instruments themselves.
These contracts have been under a cloud for years, but the investment community ignored that fact and the business in these financial instruments has soared to hundreds of millions of dollars a year, though no one knows the precise size of the market. Trouble came last year, when attention was brought to their ambiguous legal status by CFTC hints that it might move to regulate these contracts.
By law, the CFTC only regulates futures contracts, which lock in future prices on commodities as diverse as gold and pork bellies. Futures contracts on stocks and corporate bonds were ruled illegal in the early 1980s because the CFTC and the Securities Exchange Commission could not agree on which agency should regulate them. Therefore, if the CFTC regulated these contracts, they would, by definition, become futures on stocks and corporate bonds and, in the process, illegal.
The recommendation will come in a report by the President's Working Group on Financial Markets, which has been studying derivatives of all types in the wake of the near-collapse of a giant hedge fund in Connecticut a year ago whose troubles regulators feared could cause a meltdown of the entire U.S. financial system.
The CFTC, SEC, Treasury, Federal Reserve Board and other federal financial regulators are part of the group.