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Academic

: Conglomerate

Treasury Calls for Derivatives Regulation

By Gordon Smith, Christine, Hurt, Vic Fleischer, Fred Tung, Lisa Fairfax, David Zaring

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The suggestion is to put derivatives on exchanges (to be precise, "The Commodity Exchange Act (CEA) and the securities laws should be amended to require clearing of all standardized OTC derivatives through regulated central counterparties (CCP)"), but there may be "tighter regulation" as well, mostly recordkeeping, margin requirements, and "Authority to set position limits on OTC derivatives that perform or affect a significant price discovery function with respect to futures markets"; the request is for legislation from Congress. It is hard to comment on congressional legislation as a lawyer; Congress can basically regulate any financial product in any way it chooses, nothing legal or illegal about it (I'll skip the references to due process, the commerce clause, and the nondelegation doctrine, but those are three of the most important, but not-too-toothy basic limits).

Who will regulate it? There is a logical case that the regulator ought to be a consolidated entity that could handle futures, securities, and systemic risk more generally. Indeed, Ben Bernanke's May 11 speech defending the way the bank stress tests were conducted included this observation about the value of coordinated (and perhaps even consolidated) supervision of financial institutions:

unlike traditional examinations focused on individual banks, the assessment process specifically incorporated cross-firm and aggregate analyses of a set of firms that constitute a majority of the banking system. This approach allowed a broader analysis of risks than is possible within the traditional supervisory focus on individual institutions. Supervisors evaluated loss rates for similar portfolios using consistent data and metrics, allowing them to identify outliers and more effectively evaluate the quality of individual firm estimates. The process was an iterative one, with both the firms and supervisors conducting sensitivity analyses around key assumptions. The federal bank regulators--the Federal Reserve, OCC, and FDIC--cooperated extensively throughout this process, from the design to the implementation.

But there are plenty of reasons to think carefully about consolidation, as Larry Cunningham and I write. In this, we are joined by regulatory turf protectors. Mary Schapiro made the case yesterday for the continued independence of the SEC:

I must underscore that independence is an essential attribute of a capital markets regulator that protects investors. There are other agencies of government that touch on what we do, just as what we do touches on other agencies of government. But Congress created only one agency with the mandate to be the investors' advocate.

I'm betting against consolidated supervision, but the situation is fluid, and betting, of course, is also not a signal strength of lawyers.

Full post as published by Conglomerate on May 13, 2009 (boomark / email).