In the next step towards possible federal regulation of derivatives contracts, the Senate Committee on Agriculture, Nutrition & Forestry held hearings yesterday on the “Role of Financial Derivatives in Current Financial Crisis.” The hearings follow on the heels of New York State Insurance Department’s announcement last month that it would regulate a category of credit default swaps (CDS), those for which the buyer of protection “holds, or reasonably expects to hold, a ‘material interest’ in the reference obligation.” Securities and Exchange Commission (SEC) Chairman Christopher Cox urged Congress to give statutory authority to regulate CDS and reinforced his concerns in his opening remarks to the SEC roundtable on modernizing the SEC’s disclosure system.
Witnesses at the Agriculture Committee hearings included:
- Eric R. Dinallo, Superintendent, State of New York, Insurance Department
- Dr. William K. Black, Associate Professor of Economics and Law, University of Missouri
- Dr. Richard Lindsey, President and CEO, Callcott Group, LLC
- Ananda Radhakrishnan, Director, Division of Clearing and Intermediary Oversight, Commodity Futures Trading Commission
- Terrence A. Duffy, Executive Chairman, CME Group
- Robert Pickel, Chief Executive Officer, International Swaps and Derivatives Association, Inc.
- Johnathan Short, General Counsel, Intercontinental Exchange
Although SEC Chairman Cox has pushed for legislation, the SEC was not included on either witness panel. The Committee has jurisdiction over the CFTC, and references to regulation focused on the CFTC’s role. The interest of both the SEC and the CFTC in regulation of derivatives brings to mind the long standing disagreement about jurisdiction over securities futures products, which was finally resolved under the Commodity Futures Modernization Act of 2000 and related regulations.
No new themes came out of the hearings. Members of the Committee and the witnesses repeatedly returned to the value of a central clearinghouse for over-the-counter derivatives (OTC derivatives) , the need for transparency in OTC derivatives, improved means of valuation, and concerns about systemic risk, although there was no universal view about the best way to address risks of OTC derivatives. Not surprisingly, the CFTC supported regulating all products and the CME strongly supported a centralized clearinghouse for CDS. Notably absent from the discussion was the argument at the center of earlier debates surrounding possible regulation of OTC derivatives products: too much regulation will stifle innovation in the markets. Even the representative from ISDA, the trade association for the over-the-counter derivatives industry, simply referred in his prepared statement to the value of derivatives products in allocating risks and permitting parties to take a view on market activity.
Most of the Committee members seemed interested in understanding the role of derivatives in the present financial crisis, what alternatives are available to reduce risks, and the implications of each alternative. They did not challenge the witnesses who acknowledged the contribution of derivatives to the financial system or the need for customized products that would not be traded on exchanges. Chairman Harkin spoke most strongly about the risks of derivatives, noting in his opening remarks that derivatives have amplified risks and closing the hearings by suggesting that the President’s Working Group, which advocated excluding derivatives from CFTC regulation in 1999 and 2000, doesn’t have all the answers – just opinions.
After the hearings, Chairman Harkins issued a statement indicating that he would introduce legislation to “regulate swaps and other financial derivatives that are traded with virtually no regulation or transparency.… Financial derivatives like credit-default swaps need to be traded on a regulated exchange so that we know the value of the contracts, who is trading and if they have enough assets to back the contract.”
The House Committee on Agriculture is holding hearings today on the role of credit derivates in the US economy. Witnesses from both the SEC and the CFTC are scheduled to appear.