If enacted, the proposal would provide novel regulatory authority related to OTC derivatives and other major market participants and repeal many changes that were made through the Commodity Futures Modernization Act of 2000.
On August 11, 2009, the U.S. Department of the Treasury delivered legislative language to Capitol Hill that would significantly restructure the regulatory framework that governs the market for over-the-counter (OTC) derivatives. The Treasury language changes the landscape of derivatives regulation and proposes broad-based regulatory reform of the derivatives industry, which the Obama administration first outlined in its June 17, 2009, white paper on the subject. Notably, this legislative proposal contrasts with a competing proposal introduced by Representatives Barney Frank (D-MA) and Colin Petersen (D-MN) on July 30, 2009.
New Regulatory Requirements for the OTC Derivatives Markets
The administration’s proposal would repeal sections 2(d), 2(e), 2(g) and 2(h) of the Commodity Exchange Act, create two new categories of registrants and require all “standardized” OTC derivatives, including credit default swaps, to be cleared through a derivatives clearing organization that is registered with the Commodity Futures Trading Commission (CFTC) or through a securities clearing agency that is registered with the Securities and Exchange Commission (SEC). All standardized OTC derivatives would be required to be traded on a CFTC or SEC regulated exchange or “alternative swap execution facility” (a new registration category for registered entities). Under the draft legislation, any OTC derivative that is accepted for clearing by any regulated central clearinghouse will be presumed to be a standardized contract.
The Treasury language promotes standardization in the OTC derivatives market by imposing higher capital requirements and higher margin requirements for non-standardized OTC derivatives products. Further, the proposal provides the CFTC and SEC with authority to preempt attempts by market participants to evade clearing or exchange trading requirements by customizing contracts.
Through another new registration category entitled “Swap Repositories,” the Treasury proposal gives all federal financial regulators new access to information on OTC derivative transactions, including trade and position data for counterparties. Certain information, including aggregated data on open positions and trading volumes, would be available to the general public. The proposal also raises the eligibility levels for individual investors and political subdivisions that want to engage in OTC derivative transactions.
Greater Oversight of OTC Derivatives Dealers and Market Participants
If enacted, the administration’s proposal also would provide new regulatory authority related to OTC derivatives dealers and other major market participants, which will include new reporting and recordkeeping obligations, more restrictive position limits and capital requirements. In addition, any firm that deals in, or that takes large positions in, OTC derivatives, would be subject to what the Treasury calls “robust and comprehensive” regulation by one or more federal agencies. The proposal also gives the CFTC and SEC new authority to prevent market manipulation, fraud, insider trading and “other abuses in the OTC derivatives markets.” Of particular interest is the Treasury’s proposed modification to the Excessive Speculation section of the Commodity Exchange Act and its grant of authority to the CFTC to set position limits for “swaps that perform or affect a significant price discovery function with respect to regulated markets.” Likewise, the proposal would give the CFTC the power to aggregate position limits of contracts traded on domestic exchanges, foreign boards of trade, and certain OTC swaps that perform or affect a significant price discovery function in regulated markets.