Today, the Senate Agriculture Committee held a hearing entitled “OTC Derivatives Reform Addressing Systemic Risk,” to discuss the Obama administration’s proposal and the various Congressional proposals for reform of the over-the-counter (OTC) derivatives market. The following witnesses testified at the hearing:

Panel 1

Panel 2

  • Terrence Duffy, Executive Chairman, CME Group
  • Johnathan Short, Senior Vice President, General Counsel and Corporate Secretary, IntercontinentalExchange, Inc. (ICE)
  • Peter Axilrod, Managing Director, The Depository Trust & Clearing Organization (DTCC)
  • Blythe Masters, Managing Director and Head of Global Commodities Group, JPMorgan Chase & Co.
  • Jiro Okochi, CEO,, Inc.

Secretary Geithner emphasized that “shock absorbers critical to preserving stability – capital, margin, and liquidity cushions in particular – were inadequate inside the banking sector and woefully inadequate in critical places outside the banking sector,” and thus, the Obama administration’s and Congressional proposals seek to address these inadequacies. He noted that comprehensive derivatives reform should include the following elements:

  1. Mandatory clearing of all standardized derivatives contracts: The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) should have the authority to “proactively require central clearing of derivative types that are sufficiently standardized and liquid or whose economic terms are substantially the same as contracts that are centrally cleared – regardless of whether a clearinghouse would accept the derivative type for clearing today,” and regulators must carefully monitor attempts by market participants to use false customization to avoid clearing. In response to questioning by the Committee as to whether exclusions for non-standardized contracts and exceptions for end-users would allow for market participants to avoid regulation, Secretary Geithner stated that he would work with the CFTC to find the appropriate balance in drafting carefully crafted exclusions and exceptions in such a way that they would reduce systemic risk, but also preserve innovation in the OTC derivatives markets.
  2. Capital and margin requirements: Capital and margin requirements for non-centrally cleared OTC derivatives should be increased to incentivize the migration of OTC derivatives onto central clearinghouses.
  3. Prudential supervision of OTC derivatives dealers and other major OTC derivative market participants: Subjecting OTC derivatives dealers and other major market participants to conservative capital and margin requirements and strong business conduct standards will ensure that such parties “resources necessary to make good on the promises they have made to their derivative counterparties.” Secretary Geithner also noted that the Federal Reserve would not be providing duplicative regulation to these markets, and that it was necessary for financial institutions to have a consolidated supervisor that is accountable for constraining risks.
  4. Requirements to increase transparency of OTC derivatives markets: Improved price discovery and greater price competition among dealers would result from requiring clearable derivatives to be traded on regulated exchanges or regulated electronic execution facilities. Regulators should have confidential, timely and complete access to transactions and open positions of individual market participants, while the public should have access to aggregated data on open positions and trading volumes. The CFTC and SEC should have authority to subject all OTC derivatives transactions to recordkeeping and reporting requirements, and counterparties to non-centrally cleared OTC derivatives should be required to report each transaction to a regulated trade repository.
  5. Civil enforcement authority: The CFTC and SEC should be provided with authority for civil enforcement and the regulation of fraud, market manipulation and other abuses in the OTC derivatives markets.
  6. Standards for OTC market participants: Standards to govern who may participate in the OTC derivatives markets should be tightented to prevent the use of inappropriate marketing practices to sell derivatives to unsophisticated individuals, business and municipalities.
  7. International coordination: U.S. regulators should work with international counterparts to ensure that similarly strict regulatory regimes are implemented.

The executives from the major exchanges criticized the reform provisions in the various Congressional proposals that would require OTC derivatives products be traded through exchanges or clearinghouses because it would create negative unintended consequences, such as likely increasing costs to commercial companies, and ultimately consumers. The executives also raised concerns that the provisions would give too much authority to the CFTC in regulating the exchanges and clearinghouses, which would increase compliance costs.

Representing the interests of derivatives corporate end-users, Mr. Okochi testified that “non-financial corporations using OTC derivatives to hedge specific business risks were not the cause of the recent financial crisis, and every consideration should be given to this class of users so that they are not penalized for using OTC derivatives properly.” He noted that corporate end-users had concerns over the hedging issues surrounding the standardization of derivatives trades, and the various compliance costs that such end-users would likely incur.

In other reported news, House Financial Services Committee Chairman Barney Frank stated that he and House Agriculture Committee Chairman Collin Peterson have reached an agreement on legislation to provide greater regulation to the OTC derivatives market, except for two major provisions – one regarding whether end-users should be required to put up margin for non-centrally cleared trades and the other as to whether ownership in a clearinghouse by a financial firm should be limited to a certain percentage.