Corporate Governance

Regulation of OTC Derivatives is on the Horizon

By Tamar Weinrib

Following the Obama Administration's proposals last week to bring tighter regulation to financial markets, SEC Chairwoman Mary Schapiro testified before a Senate Banking subcommittee today that it would be relatively simple to change the law to allow for the regulation of over-the-counter (OTC) derivatives and emphasized that this step is needed to help the SEC ensure the proper regulation of securities markets. Companies use OTC derivatives as a risk management tool to manage their exposure to interest rate, currency exchange rate, commodity price, and other risks inherent in their businesses. In her testimony, Schapiro said that regulating the OTC market is necessary because positions in securities-related OTC derivatives can be used to simulate positions in securities markets.  Legislation to enhance regulation of OTC derivatives has already been introduced in the House of Representatives and the U.S. Senate and is a direct reaction to the herculean growth of the $680 trillion OTC derivatives market, highly publicized issues surrounding the use of credit derivatives and crises involving major derivative counterparties such as Bear Stearns, Lehman Brothers and AIG that resulted in systemic risk to global financial markets.   Passage of any such legislation would bring OTC derivatives under a comprehensive regulatory regime for the first time.

Proponents of regulating the OTC market say that it would mean a more sound securities market in part because it would help the SEC look for fraud.  As Schapiro testified, currently it is hard to examine OTC trades for fraud because it is hard to find trade information in the unregulated market and the exclusion of certain securities-related OTC derivatives from most of the securities regulatory regime has undermined the SEC's ability to adequately protect investors.  She testified that making the necessary changes is as simple as changing the definition of "security" in current law to cover securities-related OTC derivatives as well as eliminating the ?swaps? exclusion from the laws.  Non-securities related OTC derivatives would be under the purview of the Commodity Futures Trading Commission.  With influential proponents like President Obama, Timothy Geithner, the SEC and various Congressmen behind increased oversight in the financial markets, bringing securities related OTC derivatives under regulatory control seems imminent.

Full post as published by PomTalk on June 22, 2009 (boomark / email).