Today, the President’s Working Group on Financial Markets (PWG), chaired by Treasury Secretary Paulson and including Federal Reserve Board Chairman Ben Bernake, SEC Chairman Christopher Cox and CFTC Chairman Walter Lukken,announced various initiatives to strengthen oversight and infrastructure of the over-the-counter (OTC) derivatives market. The PWG, along with the Office of Comptroller of the Currency and the Federal Reserve Bank of New York, has been actively involved in the oversight of improvements in the OTC derivatives markets.
The PWG’s highest short-term priority is the commencement of one or more credit default swap (CDS) central counterparties in order to reduce the “systemic risk associated with counterparty credit exposures” and facilitate greater market transparency. Several potential central counterparty providers have accelerated their efforts as a result of prompting by the PWG, and various regulatory bodies, including the SEC, are in the process of assessing these central counterparty proposals “by conducting detailed on-site reviews of risk management and other key design elements” and expediting regulatory approval of at least one of these proposals. Regulators expect that at least one CDS central counterparty should be operational by year-end.
To facilitate regulatory approval and promote greater consistency among regulators, the Federal Reserve, the SEC and the CFTC today signed a Memorandum of Understanding (MOU), under which the regulators will “coordinate, cooperate and share information in connection with the respective oversight, regulatory and supervisory responsibilities and authorities” of the three agencies regarding CDS central counterparties. Under the MOU, which does not create legally binding obligations between the regulators, the regulators agree to take into account, in setting supervisory expectations for central counterparties, the “Recommendations for Central Counterparties” developed by the Committee on Payment and Settlement Systems of the central banks of the Group of Ten countries in conjunction with theTechnical Committee of the International Organization of Securities Commissions.
The PWG also announced a set of additional policy objectives for OTC derivatives. The financial markets crisis prompted establishment of policy objectives which are broader in scope than those issued this past March as a part of the PWG’s Policy Statement on Financial Market Developments. The objectives, which are consistent with recommendations of the Financial Stability Forum, include improving market transparency and integrity for the CDS market, enhancing risk management of OTC derivatives, strengthening OTC derivatives market infrastructure, and continued cooperation among the regulators.
Finally, the PWG released its progress summary on OTC derivatives operational improvements since 2005, at which time U.S. and foreign financial supervisory authorities of OTC derivatives dealers expressed concern that advances in development of operational infrastructure supporting OTC derivatives had not kept pace with the rapid growth of the credit derivatives market. Since 2005, major credit derivative dealers have focused on improving automation and on developing and standardizing legal documentation to allow more products to be eligible for electronic processing. Additionally, improvements have been made in trade processing efficiency, market design and risk management.