Regulators, Industry Weigh OTC Overhaul

As the Obama administration plans to propose a comprehensive financial regulation overhaul as early as June 17, according to a report filed at Thomson Reuters, secondary market players are stepping forward with their own proposals. The new chairman of the Commodity Futures Trading Commission, Gary Gensler, testified today before a Senate committee and asks for restrictions, fees and regulations on large banks and financial institutions that participate in the derivatives market. His requests come as part of the administration’s sweeping regulatory reform. Gensler calls for a comprehensive regulatory framework to govern over-the-counter (OTC) derivative dealers and markets, lower systemic risks, promote transparency and efficiency of markets, prevent fraud and manipulation and protect the public from improper marketing practices. He also asks for requirements for capital reserves and collateral, which provide a backstop to default-related loss. His proposal imposes expenses on derivatives dealers that might end up limiting the profit they make. “The current financial crisis has taught us that the derivatives trading activities of a single firm can threaten the entire financial system and that all such firms should be subject to robust federal regulation,” he says, according to prepared remarks. But at least one securitization trade group has its own ideas of how to increase transparency within the industry without massive government regulation. The Securities Industry and Financial Markets Association‘s (SIFMA) asset management division this week issued a letter to the Federal Reserve Bank of New York outlining a framework for OTC derivatives risk management and market structure. The association, likely concerned for the way heavy OTC derivative regulation may impact the securitization industry, recommended reducing systemic risk in the OTC derivatives market without controlling the market. Credit default swaps — an OTC product meant ensure payoffs to buyers when the underlying bond defaults and a credit enhancement tool commonly used in American securitizations — may pose potential long-lasting and widespread damage. When Lehman Brothers failed, massive defaults on loans held in securitizations put bondholder payoffs in jeopardy. SIFMA recommended segregating customer collateral from portability of accounts in the event of counter-party default and updating industry governance to be more inclusive of buy-side participants, among other solutions. Regulators this week also consider ways to manage the government-sponsored mortgage giants from conservatorship even beyond the current crisis. Federal Housing Finance Agency (FHFA) director James Lockhart suggested in testimony Wednesday that the government-sponsored enterprises (GSEs) face one of three fates in terms of ownership going forward: government agencies, government-sponsored entities or fully private firms. “Recent experience has taught us that traditional prudential supervision may be insufficient to prevent the buildup of risks that threaten overall financial stability,” Lockhart said. “FHFA therefore supports a shift to broaden supervisory activities to include the monitoring of systemic risk and the development of regulatory policies that focus on systemic stability.” “Such policies,” he added, “often termed ‘macroprudential,’ include efforts to dampen credit cycles by making capital and other regulatory requirements more countercyclical.” Banking industry players are speaking up on behalf of the GSEs’ ability to operate without substantial government regulation. Representatives from the Mortgage Bankers Association, the National Association of Realtors and the National Association of Home Builders on Wednesday testified to a House Financial Services subcommittee on the future of the GSEs. The industry groups acknowledged at least some government control is required going forward, although they called for limited government in the GSEs. Write to Diana Golobay. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.