Thursday, January 7, 2010

CFTC head blames OTC derivatives for crisis

Original posted in the Financial Times by Gregory Meyer:

A top US regulator on Wednesday stepped up rhetoric calling for regulation of over-the-counter derivatives, saying they were at the heart and not a side effect of the financial crisis.

Gary Gensler, chairman of the Commodity Futures Trading Commission, said Wall Street dealers need to be “explicitly” regulated for derivatives transactions, in addition to existing government oversight, as the risks of unregulated derivatives could bring down the financial system.

“Some opponents of reform - some I would say in this room - would say this really wasn’t at the centre of the crisis, the crisis was about mortgage underwriting practices, the crisis was about not enough capital in the banks and so forth,” Mr Gensler said in a speech to the Council on Foreign Relations in New York.

“But I believe that the over-the-counter derivatives marketplace was in fact part and parcel to this crisis.”

Participants listed in the event programme included nine names from Goldman Sachs, where Mr Gensler worked for 18 years, along with several others from banks including Barclays Capital, Credit Suisse, JP Morgan and Morgan Stanley.

Asked who opposes derivatives reform, Mr Gensler said, apparently half-jokingly: “Many people in this room. You can look at the programme in the back.” He later called opponents “primarily the five or six largest Wall Street firms. They have a fiduciary duty to shareholders to maximise profits. The information advantage is theirs right now.”

Mr Gensler has called repeatedly for a centralised market where prices are more transparent to traders and regulators. In the seven months since the Obama administration kicked off sweeping reforms of the OTC derivatives markets, lobbying from banks, companies and others has intensified. They argue that all OTC derivatives are being unfairly targeted for reform because it was only part of the markets - credit derivatives - that was at fault during the crisis.

Mr Gensler has repeatedly said that reforms must encompass all OTC derivatives because they are opaque, lightly regulated and could pose risks to the financial system. The European Commission has taken a broadly similar approach.

Mr Gensler spoke as the US Senate takes up a bill to regulate OTC derivatives, which were central to the collapse of Lehman Brothers and AIG’s brush with extinction before its taxpayer bailout. A bill regulating such derivatives passed the US House of Representatives last month.

Mr Gensler downplayed risks of regulatory arbitrage, as some industry participants fear may be possible, if the US and Europe end up diverging in their approach to OTC derivatives reform.

He said a European Commission proposal on reform was consistent with US efforts to the extent that it would require all standardised derivatives to be cleared and centrally traded. Mr Gensler estimated that 80-85 per cent of the OTC derivatives market is located in Europe or the US.

Japan, China and Canada were co-operative, he said, although “Hong Kong is not as engaged right now”.

Some have been concerned that capital charges for derivatives contracts that are not cleared in clearing houses could differ across jurisdictions, creating an incentive for traders to flock to a low-cost, potentially higher-risk, location.

Mr Gensler said: “The large financial intermediaries are global in nature. If there’s comparable and consistent regulation overseas, we should be allowed as regulators here to recognise that.”

He said he was optimistic international regulators would co-operate to create consistent capital charges.

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