In our previous articles on the Regulation of Credit Default Swaps, published on September 26, 2008 and November 28, 2008, we described how regulators in the United States and Canada were addressing the issues of systemic risk and the instability of the financial system attributed to credit default swaps in the aftermath of the financial credit crisis that started in the summer of 2007. While there are many areas in which regulation is seen to be necessary, the largely unregulated, privately negotiated, over-the-counter (OTC) derivatives market, which includes credit default swaps, is receiving the most attention.

On May 13, 2009, Secretary of the US Treasury Timothy F. Geithner sent a letter to US congressional leaders outlining proposed amendments to the Commodity Exchange Act, securities laws and other relevant laws that Secretary Geithner believes are needed to enable the US government to effectively regulate the OTC derivatives markets. In June, the US Treasury Department detailed these plans more fully when it rolled out its proposal for overall financial regulatory reform. On July 10, 2009, Secretary Geithner testified at a joint hearing of the House Agriculture Committee and the House Financial Services Committee on the US federal administration’s proposal for a comprehensive regulatory framework for the OTC derivatives markets. He indicated that the forthcoming legislation would not be overly specific and would leave many of the details to the actual regulators.

The US Treasury Department has outlined four main public policy objectives to be achieved by government regulation of the OTC derivatives markets: (1) preventing activities in OTC derivatives markets from posing risk to the financial system; (2) promoting the efficiency and transparency of the OTC derivatives markets; (3) preventing market manipulation, fraud and other market abuses; and (4) ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties. Some of the specific steps proposed to achieve these objectives include (a) imposing record-keeping and timely reporting requirements on all OTC derivatives; (b) requiring all standardized OTC derivative transactions to be executed in regulated and transparent venues, and cleared through regulated central counterparties; and (c) harmonizing the laws that govern the regulation of futures, derivatives and securities, as well as both the Commodities Futures Trading Commission and the Securities and Exchange Commission, so as to allow these bodies to police fraud and effectively regulate the derivatives market, among others.

As discussed in our previous two articles, Alberta, British Columbia and Québec have adopted rules and legislation regulating OTC derivatives. Ontario is still considering its proposed Rule 91-504 dealing with OTC derivatives. However, none of the Canadian provinces have rules in place, nor has any province publicly announced that it is considering rules that require centralized clearing of OTC derivatives. Furthermore, the rules and legislation that have been adopted do not deal with the excessive recordkeeping and reporting requirements proposed by the US Treasury Department.

Many commentators point to the largely unregulated OTC derivatives market, in particular, credit default swaps, as being the catalyst for the current global credit problems. Whether one agrees with that view or not, it appears that all interested parties welcome the regulation of OTC derivatives at some level. Although US politicians appear to be moving toward establishing a framework for regulation of OTC derivatives, there are still many unanswered questions, such as how a "standardized" OTC derivative will be defined and who will make that determination.

On August 11, 2009, the US Treasury Department delivered draft legislation (Over-the-Counter Derivatives Markets Act of 2009) to Congress. It will work with Congress with a view to passing legislation by the end of the year.

For a detailed discussion of these issues, please see our June 2009

Legal Update.

For a discussion of derivatives legislation in Québec, please see our August 2009 Legal Update and our November 2008 article.