6.22.2009 SEC Chairman Mary Schapiro testified before the U.S. Senate Subcommittee on Securities, Insurance, and Investment of the Committee on Banking, Housing, and Urban Affairs concerning the regulation of OTC derivatives and the “gap in regulation of OTC derivatives, which under current law are largely excluded or exempted from regulation.” The Chairman gave an overview of the OTC derivatives markets and then outlined an approach that would address the “existing gaps” in regulatory oversight of these securities-related OTC derivatives.

To start, the Chairman commented that it was difficult for her, or any U.S. regulatory authority, to give a “complete picture” of OTC derivatives and how they have affected the regulated securities market because of the current limited regulation of OTC derivatives. However, the Chairman happily reported that regulatory authorities agreed on the need for comprehensive regulations for OTC derivatives, which would include requiring well-regulated central counterparties (CCPs) to address concerns about counterparty risk by substituting the creditworthiness and liquidity of the CCP for the creditworthiness and liquidity of counterparties.

When addressing how to fill the “regulatory gaps,” the Chairman dovetailed her recommendations with Treasury Secretary Timothy Geithner’s May 13 letter to the Congressional leadership, which outlined the Obama Administration’s plan for establishing a comprehensive framework for regulating OTC derivatives. Chairman Schapiro stated that her testimony was intended to recommend a straightforward and principled approach for achieving the same policy objectives as Secretary Geithner had outlined.

Primarily, the Chairman stated that responsibility for securities-related OTC derivatives should be retained by the SEC.

The Chairman supported her decision based on the close relationship between the regulated securities markets and the markets for securities-related OTC derivatives and how oversight of such instruments could be integrated with the SEC’s existing oversight of the securities markets. The Chairman stated that to provide a unified, consistent framework for securities regulation, Congress should subject securities-related OTC derivatives to the federal securities laws simply by clarifying the definition of “security” to expressly include securities-related OTC derivatives and removing the current express exclusion of swaps from that definition. She stated that this result can be achieved simply by clarifying the definition of “security” to expressly include securities-related OTC derivatives and by removing the current express exclusion of swaps from that definition. The SEC then would have authority to regulate securities-related OTC derivatives regardless of how the products are traded, whether on an exchange or OTC, and regardless of how the products are cleared.

Click http://www.sec.gov/news/testimony/2009/ts062209mls.htm to access Chairman Schapiro’s testimony.