By a vote of 43 to 26, the Financial Services Committee passed legislation today to regulate the over-the-counter (or OTC) derivatives marketplace for the first time. This legislation is a critical part of broader financial regulatory restructuring Congress and President Obama are working on in response to last year's financial crisis.
O.T.C. trading in credit default swap derivatives, or C.D.S.'s, brought our banking system to its knees.
The crisis began when the insurance giant American International Group disclosed that it had suffered huge losses trading C.D.S.'s, derivative bets that companies or municipalities would default on their bond obligations. Because A.I.G. was part of an enormous and poorly understood web of derivative bets and counterbets among the world's largest banks and investment funds, many of these institutions feared that if A.I.G. went bankrupt, they would too. Only a $180 billion government bailout kept the system from imploding.
With passage of this legislation, Chairman Barney Frank explained “there will be no more hidden trades where we don’t know the price.” The bill brings previously private trades into the light of day, making standardized swap transactions between dealers and large market participants trade on an exchange or electronic platform, with regulatory authority and oversight by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission.
Speaker Pelosi on today’s committee action:
Today's House Financial Services Committee vote to reform regulation of the over-the-counter derivatives market is a critical step forward in Congress' efforts to pass comprehensive financial regulatory reform. The House Agriculture Committee will now have the opportunity to add its input and expertise to this legislation.
The House is taking action to restore transparency, accountability, and investor confidence to our financial markets. In July, we passed legislation to give shareholders of public companies a say on executive pay, and this week, the Financial Services Committee continued consideration of a bill to create a Consumer Financial Protection Agency.
Working with the Chairmen and our Members, we look forward to scheduling a vote by the full House on a comprehensive financial regulatory reform package.
Learn more about the Over-the-Counter Derivatives Markets Act of 2009 from the Financial Services Committee:
The legislation provides a mechanism to determine which swap transactions are sufficiently standardized that they must be submitted to a clearinghouse. For transactions that are clearable, clearing is a requirement when both counterparties are either dealers or major swap participants. Clearing organizations must seek approval from the appropriate regulator–either the CFTC or the SEC–before a swap or class of swaps can be accepted for clearing.
Transactions in standardized swaps that involve end-users are not required to be cleared. Such customized transactions must, however, be reported to a trade repository.
Mandatory Trading on Exchange or Swap Execution Facility
A standardized and cleared swap transaction where both counterparties are either dealers or major swap participants must either be executed on a board of trade, a national securities exchange or a “swap execution facility”–as defined in the legislation. If none of these venues makes a clearable swap available for trading, the trading requirement would not apply. Counterparties would, however, have to comply with transaction reporting requirements established by the appropriate regulator. The legislation also directs the regulators to eliminate unnecessary obstacles to trading on a board of trade or a national securities exchange.
Registration and Regulation of Swap Dealers and Major Swap Participants
Swap dealers and major swap participants must register with the appropriate Commission and dual registration is required in applicable cases. Capital requirements for swap dealers’ and major swap participants’ positions in cleared swaps must be set at greater than zero. Capital for non-cleared transaction must be set higher than for cleared transactions. The prudential regulators will set capital for banks, while the Commissions will set capital for non-banks at a level that is “as strict or stricter” than that set by the prudential regulators.
The regulators are directed to set margin levels for counterparties in transactions that are not cleared. The regulators are not required to set margin in transaction where one of the counterparties is not a dealer or major swap participant. In cases where an end user is a counterparty to a transaction, any margin requirements must permit the use of non-cash collateral.
Reporting and Public Disclosure of Swap Transactions
Reporting and recordkeeping is required for all over-the-counter derivative transactions. Clearing organizations must provide transaction information to the relevant Commission and a designated trade repository. Swap transactions that are not cleared and for which no trade repository exists, must be reported directly to the relevant Commission. The legislation also provides for public disclosure of aggregate data on swap trading volumes and positions–in a manner that does not disclose the business transactions or market position of any person. Large positions in swaps must also be reported directly to regulators.
Swap Execution Facilities
Swap execution facilities, or facility for the trading of swaps that are not Boards of Trade or National Securities Exchanges, must register with the relevant regulator as a swap execution facility (SEF). SEFs must also adhere to core regulatory principles relating to enforcement, anti-manipulation, monitoring, information collection and conflicts of interest, among others. The CFTC and SEC are required to prescribe joint rules governing the regulation of swap execution facilities. A Commission may exempt a SEF from registration if it is subject to comparable, comprehensive supervision and regulation by another regulator.