Upon the anniversary of the Lehman Brothers bankruptcy — the event many measure as the beginning of the current financial crisis, though it more accurately could be described as the moment the crisis could no longer be ignored — nothing is settled except for the general understanding that more regulation is on the way.
The Obama Administration’s proposal calls for “harmonization” of the Commodity Futures Trading Commission (CFTC) and Securities Exchange Commission (SEC), requires standardized over-the-counter (OTC) derivatives, including credit default swaps (CDS) to be centrally cleared and traded on exchanges, requires higher capital and margin requirements for non-standardized OTC derivatives and calls for a systemic risk regulator to oversee it all. The latter also is part of the European overhaul (see “Regulating a continental structure”). Complicating this is the evolving and increasingly interconnected nature of global futures, securities and options markets and the clearing structures that support them (see “New world disorder”). Click here for "New world disorder" chart.
The most recent piece of legislative language based on the proposal was delivered to Capitol Hill in August, resulting in the Over-the-Counter Derivatives Markets Act of 2009. On Oct. 2, House Financial Services Committee Chairman Barney Frank circulated a discussion draft of the bill. The draft of the legislation appeared to expand some exemptions to mandatory clearing by end users according to initial analysis, which would likely face challenges.
Industry leaders met with CFTC and SEC commissioners on the agencies’ harmonization efforts in September. In his testimony, CME Group CEO Craig Donohue warned that “merger of the existing regulatory structures into a single set of one-size-fits-all rules administered by separate agencies will do substantially more harm than good.” Options leaders including Chicago Board Options Exchange Chairman Bill Brodsky and Options Clearing Corporation Chairman Wayne Luthringshausen called for a focus towards the CFTC’s principles-based approach vs. the SEC’s rules-based approach to regulation. Several panelists cited past regulatory stalemates that resulted in delays for the introduction of new products such as credit default options and options on gold and silver ETFs.
“One of the questions we think about is whether this [harmonization] approach will work over the longer term as new products and new participants come into the market that they haven’t thought of during these harmonization discussions,” says Gary Katz, President and CEO of the International Securities Exchange. “Instead, we would like to see a risk-based approach to regulation. It’s our hope that as they continue these discussions and think about systemic risk, they focus on the areas in the market that have the greatest risk and potential system-wide impact and don’t take a one-size-fits-all approach.”
Gary DeWaal, general counsel for Newedge, says “Ideally, there should be the creation of a single financial regulator. That’s not going to happen, so the next best thing is greater harmonization.”
Susan Milligan, senior vice president of government relations for the Options Clearing Corporation, says if the SEC moves in a principles-based direction, there are routine rule approvals that would move much more quickly. She adds that one of the positive effects of harmonization for traders would be speedier product approvals. “Options on the gold ETF took three years to come to market. People wanted to trade them and couldn’t.”
Katz agrees. “If the SEC adopts the more CFTC-like approach to product approval and exchange rule filings, then traders and customers would have more choice — we would be able to introduce new products more quickly, and that would be very beneficial in this environment,” he says.
Richard Strait, managing partner of Richard Strait, LLC, a guaranteed broker to Triland USA, says “Securities markets are miles behind the futures markets with regard to clearing of risk. For the financial futures that are coming onto the marketplace from the OTC side, the SEC is going to have to formulate their policy [to make it] more in line with what the CFTC does.”
Efforts to move towards portfolio margining across products — something the regulators have struggled to work together on — also are part of the harmonization discussion. Options experts say that current rules, as well as the current account minimum for portfolio margining of $100,000 make it difficult to effectively use an account that has futures and equities and equity options. “Our customers are still handcuffed by margin rules that don’t take into account the sophistication of the products,” says Peter Bottini, vice president of trading at optionsXpress. “Securities margin requirements are very outdated and very inappropriate for customers who are using complex strategies.”
Milligan says, “If customer portfolio margining, which includes both futures and securities, could finally happen, that could be a really