Tuesday, May 26, 2009

Wall Street Derivatives Proposals Adopted in Treasury Overhaul

Posted on Bloomberg by Matthew Leising:

Wall Street’s largest banks are getting what they want in the U.S. Treasury’s plan to regulate over-the-counter derivatives by making all market participants adhere to the same capital requirements.

Goldman Sachs Group Inc., JPMorgan Chase & Co., Credit Suisse Group AG and Barclays Plc sent the Treasury a plan written in February saying the Federal Reserve should extend bank regulation practices to companies and hedge funds, according to a document obtained by Bloomberg News and confirmed by the Treasury. Corporations, energy companies and hedge funds don’t face capital and margin levels now, while banks do under central bank oversight.

“The banks appear to wish to maintain the intra-dealer market and raise barriers to new entrants to keep the OTC business as compartmentalized as possible and to protect their profitable market conditions,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. “The Street’s lobbyists appear to be asking for a ‘club’ structure in OTC trading.”

On May 13, U.S. officials called for increased oversight in the $592 trillion unregulated market to reduce risk to the financial system. Derivatives contributed to the failures last year of Lehman Brothers Holdings Inc. and American International Group Inc., leading to the seizure of credit markets and causing more than $1.4 trillion in writedowns and losses amid the worst financial crisis since the Great Depression.

‘Little Impact’

The Treasury hears from many interested participants while crafting policy, said spokesman Andrew Williams. Derivatives are contracts whose values are tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

“This proposal had little impact on our final result,” he said. “Our proposal calls for dramatically increased transparency and the enhancement of regulatory powers to prevent market manipulation that go well beyond anything in that draft.”

Bruce Corwin, a spokesman for Zurich-based Credit Suisse, Goldman Sachs spokesman Michael DuVally and JPMorgan spokesman Brian Marchiony declined to comment on the bank draft. Representatives of London-based Barclays didn’t immediately return calls and messages for comment left after normal business hours.

Treasury Secretary Timothy Geithner sent a proposal to Congressional leaders on May 13 laying out his plan to police the market where swaps based on interest rates, currencies, commodities and a company’s ability to repay debt are traded.

‘Robust Regime’

“All OTC dealers and other firms who create large exposures to counterparties should be subject to a robust regime of prudential supervision and regulation,” the proposal said. These included “conservative capital requirements,” “reporting requirements,” and “initial margin requirements.”

The bank-written plan, titled “Outline of Potential OTC Derivatives Legislative Proposal” and dated Feb. 13, said the systemic regulator “shall promulgate rules” requiring “capital adequacy,” “regulatory and market transparency” and “counterparty collateral requirements.”

Hintz said Wall Street revenue from trading fixed-income, commodities and currency swaps in the over-the-counter market may be reduced by 15 percent under the Treasury’s changes. “Limiting potential competition” in the market “may not be an unreasonable position to take” by the banks due to the potential loss of income, he said.

“Better the devil you know than the devil you don’t,” said Robert Webb, a finance professor at the University of Virginia in Charlottesville, describing the bank’s preference for their current regulator.

Shifting Views

The banks sought sole authority for the Fed over the market and limited the role of the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission, according to the document. The three agencies currently share information in the $28 trillion credit-default swap market.

Geithner’s proposal didn’t specify what agency or combination of agencies should oversee the market.

Investment banks fought regulation of OTC derivatives for more than a decade because the contracts provide a significant portion of bank earnings. As much as 40 percent of the profit for dealers Goldman Sachs and Morgan Stanley comes from the trading, according to fixed-income research firm CreditSights Inc. JPMorgan made $5 billion in profit last year from trading in fixed-income OTC derivatives, according to people familiar with the earnings.

Systemic Risk

The Obama administration favors the Fed becoming the new systemic risk regulator to oversee financial companies that could pose a danger to the banking system, according to participants in a May 8 White House meeting.

While the central bank has been favored to take the job since a proposal by former Treasury Secretary Henry Paulson last year, lawmakers and some regulators have shifted away from that view. Federal Deposit Insurance Corp. Chairman Sheila Bair and SEC Chairman Mary Schapiro earlier this month recommended that a council of regulators assume the role.

Geithner’s plan goes further in many aspects than what the banks laid out in their draft.

The Treasury Secretary is proposing mandatory guaranteeing of private contracts with clearinghouses for standardized OTC contracts such as interest-rate swaps or indexes of credit- default swaps and increased electronic trading to improve price transparency for customers. He also wants required reporting of positions and trades.

No Endorsement

The bank proposal doesn’t endorse clearing of OTC derivatives. In annotations to the draft it states: “Note that the proposed outline does not propose any specific OTC derivatives clearing requirement.” It also says reporting requirements on trade data should be made to regulators “upon request.”

Webb said any regulation over the market should be applied evenly. “It’s not clear requiring everyone to have the same capital requirements is necessary,” he said. He added that banks have worked closely with the Fed for many years.

“You’re going to see some close ties between the industry and the regulator,” he said.

No comments: