A new bill was put into the regulatory melee for over-the-counter (OTC) derivatives, but the overall direction of the legislation is still uncertain.
On Dec. 2, Senate Agriculture Committee Chairman Sen. Blanche Lincoln (D-Ark.) said the committee would produce a bipartisan OTC derivatives bill to “provide greater oversight and transparency to the nation’s financial markets.” According to a Senate Agriculture Committee spokesperson, it is too early to know exactly what will differ in this bill from the ones already introduced in the House and Senate.
On Dec. 11, the House passed H.R. 4173, the Wall Street Reform and Consumer Protection Act of 2009, which calls for all standardized swap transactions between dealers and major swap participants to be cleared and traded on an exchange or electronic platform. In a statement, Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler said, “I commend the House of Representatives for passing historic, landmark legislation that, for the first time, will bring regulation to the over-the-counter derivatives marketplace.”
In testimony before the House Committee on Energy and Commerce on Dec. 2, Gensler restated the CFTC’s position that OTC derivative transactions be moved onto regulated exchanges, reiterated the agencies’ proposal to introduce position limits in the energy markets and called again for more stringent recordkeeping for swap dealers and participants.
At OTC regulation hearings before the Senate Committee on Agriculture on Dec. 2, leaders from both CME Group and the Intercontinental Exchange (ICE) condemned parts of the pending legislation. “Simply banning [OTC] products, transactions or certain market participants will only create further disruptions in the market and harm U.S. business, potentially driving participants to use non-U.S. venues,” said Johnathan Short, senior vice president and general counsel at ICE.
CME Group Executive Chairman Terry Duffy said “any attempt to use position limits [to control price] will have a devastating impact on the U.S. futures industry” and said that legislators should encourage, but not mandate, exchange trading and centralized clearing for OTC derivatives.
“The government has missed the big idea. All OTC derivatives have been tarred with blame for the financial crisis and that’s not true,” says Bob Park, CEO of FINCAD. “Suggesting that all OTC derivatives be moved to exchanges is a draconian response. It’s trying to solve a problem that doesn’t exist.”
Lawmakers still have to produce a final Senate bill and then go into conference to work out the differences, which Gary deWaal, general counsel at Newedge, says will be profound. “You’re not going to see momentum [on the bills] gaining traction again until late January-early February. By the time the House and Senate get together to propose a final bill, there will be one or two things in it that we don’t even contemplate today. To resolve some of the sticky issues, something new will come up that may or may not be related to financial services,” he says.
John Avery, partner at Sungard Consulting Services, says if standardized contracts move to a cleared model, there will be some implicit or explicit pricing in of additional costs. “Traders are concerned about what this means economically to their trading strategies because if [prices] change, it may make certain hedging strategies have different profitability profiles than they have in the existing bilateral world. [Traders] need to be aware of what changes [in operational costs] will be and the operations world is dealing with the need to support what will likely be a combination of bilateral and cleared OTC derivatives trades.”
DeWaal says the legislation will result in new trading opportunities. “People are misreading what the [CFTC] is trying to do. The [CFTC] is not trying to reduce the overall size of the marketplace, they’re trying to reduce the concentration of a few players. I could see more index funds developing and that might actually increase the volume in commodities. The more specific Congress is, the more volatile it’s going to make the markets, and that’s always good for traders.”