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Ag Committees Push CFTC Control of Unregulated Contracts

DTN News
November 20, 2008
By Chris Clayton

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WASHINGTON (DTN) -- Unregulated swap or derivative contracts would be considered futures contracts and regulated by the Commodity Futures Trading Commission under legislation introduced Thursday by Senate Agriculture Committee Chairman Tom Harkin.

While the House Agriculture Committee held a hearing Thursday, probing the competing oversight efforts and perceived power struggles among the nation's major financial regulators, Harkin sought to introduce his legislation.

House Agriculture Committee members, without acknowledging Harkin's bill, made it clear they also want the CFTC to take the lead role regulating swaps and other derivatives. House Agriculture Committee Chairman Collin Peterson, D-Minn., grilled Securities and Exchange Commission and Federal Reserve staffers about why they are seeking oversight in futures contract clearing, an area of regulation they have not gotten into before.

"I am concerned why we want to get another entity with no experience into this," Peterson said.

Rep. Bob Goodlatte, R-Va., panned the idea of merging the CFTC and SEC into one regulatory entity to oversee financial markets.

"This is not going to solve anything and it is not an approach we should pursue," Goodlatte said.

Right now, regulations for swaps remain at a stalemate because of the bureaucracy battles. Different proposals place oversight of swaps and derivatives under the CFTC, the Securities and Exchange Commission or the Federal Reserve.

"What I am trying to understand is why this is being bogged down here," Peterson said.

Peterson said he didn't like what appears to be an effort by the SEC to declare swaps as security transactions. Peterson noted one of the few consensus items from the G-20 summit earlier this month in Washington was that there needs to be a swap clearinghouse created as soon as possible.

"That was what everyone agreed needs to happen, but it's not happened," Peterson said.

After the hearing, Peterson said the quicker the federal government can get a regulated exchange clearing swaps, the sooner many financial risk problems can be solved. The problem with SEC or Federal Reserve oversight, he said, is it would create new agencies, regulations and authority that could take several months to implement. Or, if Congress does a "super-regulation overhaul," it could take even longer to merge the SEC and CFTC. Peterson pointed to the creation of the Department of Homeland Security, which took as long as three years to integrate roles from other government departments.

"Our position is the CFTC can do this," Peterson said. "The CFTC has the authority to do this. The CFTC has the law, the track record -- they have never lost any money -- I have confidence in them and we need to get it going, period."

Harkin, D-Iowa, on Thursday introduced the Derivatives Trading Integrity Act, which would require all such contracts be traded on a regulated exchange under the oversight of the CFTC. The bill would also end the CFTC's authority to grant exemptions for certain contracts or transactions for a commodity on future delivery.

"Every swap, every derivative, every future will have to be traded on a regulated exchange," Harkin said. "In effect, that's what it means, all of it will be on a regulated exchange."

One of the key pieces in the collapse of the financial markets was the expansion of over-the-counter swap trade that soared in recent years between major investors, corporations and banks. Credit-default swaps, for instance, were perceived as insurance contracts that required one party to pay the other in the case of major credit events, such as drops in stock value. Too many large investment banks held or backed swap contracts that kicked in as loans were defaulted on and credit ratings tumbled for banks and investment firms.

Credit-default swaps may have had a contract value as high as $60 trillion, though the actual market value of swaps is now widely regarded as significantly less. The problem is that is there is no reporting requirement or way of price discovery. The $60 trillion figure reflects the flaw, given that the number is higher than the entire gross product of the world.

Swap supporters maintain they act as customized contracts to match a particular need in hedging or price exposure. That differs from the futures market, which involves standard contracts that are more liquid, but may not meet the needs of a hedger or speculator.

Regulators and Congress are looking for a way to define credit-default swaps and derivatives and place those contracts on regulated clearinghouses, whether over-the-counter or directly on transparent exchanges.

Harkin said placing swaps as regulated contracts would mean that they would meet daily reporting and margin requirements.

Putting forward a bill so late in the year, Harkin acknowledged there was no way the legislation could be passed this session. Harkin said the bill was a "marker" to set hearings and reintroduce the bill when Congress convenes again in January.

"I wanted to get it out there and test the waters on it and see what kind of reaction we get," Harkin said.

The House Agriculture Committee is planning a trip in late November to London and Brussels, Belgium, to discuss how European regulators clear swaps and what other regulatory changes could be made in conjunction with each other. Peterson said the committee will hold a hearing again in December on the House legislation.

Harkin said he doesn't want to get into turf battles between the regulatory agencies and is open to the idea that the SEC and CFTC could merge into one entity. Still, Harkin said the U.S. financial system doesn't need the risk of unregulated futures contracts.

"We must outlaw, ban any kind of over-the-counter swaps or derivatives," Harkin said. "They must be on an exchange."

Harkin said there is an opportunity to work with other governments and foreign regulators to have a better response. Investors also are going to be looking for greater insurance and regulation of counter-party risk. Harkin also dismissed some concerns raised in the debate over regulations that some exchanges could simply move overseas to avoid U.S. regulations.

"Unregulated exchanges in a foreign market would only be interesting to those wanting to get into higher-risk," Harkin said. Dealers in the U.S. should be prevented from getting involved in those unregulated markets, he said.

The CFTC, Federal Reserve and SEC did sign a memorandum of understanding last week that emphasizes the need for centralized clearing of credit-default swaps as a way to restore some integrity to the U.S. financial markets. The Chicago Mercantile Exchange and the Intercontinental Exchange, or ICE, have both submitted proposals to clear swaps. Under the Chicago Mercantile proposal, the CFTC would be the primary regulator while under the ICE plan the Federal Reserve would have chief oversight responsibilities.

The New York State Insurance Department announced it would create a regulatory structure for default swaps, but the Department Superintendent Eric Dinallo told the Agriculture Committee Thursday his office is now putting that plan on hold due to the "progress being made to create central counterparties for credit-default swaps with federal oversight."

Chris Clayton can be reached at chris.clayton@dtn.com

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