On July 30, 2009, Congressman Collin Peterson, Chairman of the House Agriculture Committee, and Congressman Barney Frank, Chairman of the House Financial Services Committee, released a concept paper on forthcoming legislation addressing derivatives regulation. The paper outlines principles for a new U.S. regulatory regime for derivatives. Under the proposal, “strong incentives” (such as “significantly higher” margin and capital charges for non-standard or not centrally cleared or exchange-traded transactions) would encourage derivatives trading to move onto an exchange or an electronic platform. Clearing through a regulated clearinghouse would be mandatory with limited exceptions. And, “robust oversight” would include trade reporting, regulation of clearinghouses for derivatives (by a market regulator, and away from the Federal Reserve, in the case of credit default swaps (“CDS”)) and a role for the Financial Services Oversight Council (discussed elsewhere in this issue) to “resolve disputes” between the SEC and CFTC over authority over new products and joint regulation of existing products.
To supplement its “incentives,” the new regime would give regulators the authority to prohibit or further regulate transactions not traded on an exchange or centrally cleared, and “in order to prevent abuse,” a regulator would be authorized to impose position limits and ban non-dealers from buying credit protection. The concept paper targets regulation of so‑called naked CDS – the proposed regime would prohibit buying credit protection without ownership of referenced securities, a position in a related index or a bona fide economic interest to be protected – and would require reporting of short interests in CDS. However, the concept paper leaves open the question of whether centralized clearing and other measures offer an alternative to banning naked CDS contracts. In addition, the concept paper fails to address key issues such as which of the CFTC and the SEC will have authority over which derivative products, clearinghouses, reporting and other relevant matters.
In the proposed regime, U.S. regulators would coordinate with their non-U.S. counterparts to establish international standards for clearinghouses and otherwise harmonize new OTC derivatives regulation internationally. The Treasury would be authorized to restrict access the U.S. banking system for institutions from jurisdictions with lower capital-related standards or standards that “promote reckless market activity.”The principles outlined in the concept paper are generally consistent with priorities set out in the Treasury’s June 2009 White Paper on financial regulatory reform (as discussed in the June 23, 2009 Alert). The concept paper and the White Paper share goals such as addressing gaps and inconsistencies in the regulation of derivatives by the SEC and CFTC, preventing activities in the derivatives market from being a “source of contagion through the financial sector,” promoting transparency and preventing market manipulation. The concept paper also echoes recommendations from the Committee on Capital Markets Regulation’s report “The Global Financial Crisis A Plan for Regulatory Reform (5/26/09),” which include not prohibiting CDS contracts categorically, introducing mandatory centralized clearing (with some exceptions) and increased capital requirements for non-standard transactions, including those contracts settled outside the centralized clearing process.