The US government and regulators are stepping up their efforts to bring the wilder reaches of the vast credit derivatives market under central supervision for the first time.
Gary Gensler, chairman of the Commodity Futures Trading Commission, appeared before lawmakers on Capitol Hill yesterday to push for a regime that forces new restrictions on trading in the $700 trillion (£431trn) over-the-counter (OTC) derivatives market. The plans – first suggested by Timothy Geithner, Treasury Secretary, last month – will impose higher costs on banks in an area that accounted for a large chunk of the profitability of their trading operations, and Wall Street lobbyists are already attempting to limit the scale of the regulatory clampdown.
"We must urgently enact broad reforms to regulate over-the-counter derivatives," CFTC chairman Gary Gensler told a Senate committee. "Such reforms must comprehensively regulate both derivative dealers and the markets in which derivatives trade. This is vitally important for the future of our economy and the welfare of the American people."
OTC derivatives are contracts traded between banks, rather than on exchanges, and the lack of central clearing of trades and the limited amounts of collateral often required by counter-parties proved particularly dangerous as the market grew in size.
The fortunes of giant financial institutions became knitted together through the trading of bespoke contracts called credit default swaps, so much so that when Lehman Brothers and AIG got into trouble, they threatened to bring down the financial system. "We should require that all derivatives that can be moved into central clearing be required to be cleared through central clearing houses and brought on to regulated exchanges or regulated electronic trading systems," Mr Gensler said.
Under the new regime, derivatives dealers would be subject to capital requirements, initial collateral requirements, business conduct rules, and reporting and record-keeping rules. The CFTC would also have the power to limit the size of positions dealers could take, if it believes prices are being affected.
In order for derivative contracts to be tradeable on an exchange they must be standardised, something which would make them much less profitable for banks. Wall Street has been pushing back against the statutory rules that the CFTC and Treasury are pressing, and an industry group earlier this week proposed a voluntary code of conduct.
Although Mr Gensler's plan would continue to allow bespoke products, they would be overseen by regulators, too, he insisted.