US prepares sweeping rules on derivatives: Washington proceeds despite British opposition

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The Independent Online
DESPITE months of assurances to the contrary from a variety of American banking and securities authorities, Washington is preparing to propose new regulations on the burgeoning trade in derivatives, perhaps as early as this week.

This is in direct opposition to UK authorities, led by the Bank of England, which believe that existing regulatory structures can handle the industry.

Derivatives started off as a method by which companies could insure themselves against unexpected movements in interest rates, foreign exchange rates and the like. They are traded at one or two removes from the underlying cash market, giving the right to buy at some point in the future.

The US authorities are concerned with three developments: the way inexperienced companies and public bodies have lost heavily on derivatives; the spiralling use of derivatives by highly speculative 'hedge funds', such as those run by George Soros; and the high fees that financiers charge for providing these fancy products, as opposed to simpler instruments.

In recent months large companies have disclosed a rash of heavy derivatives trading losses. Over the weekend Atlantic Richfield confirmed that investments in derivative securities were the cause of a dollars 22m ( pounds 15m) loss incurred last month in one of the employee investment funds it manages, representing 5 per cent of the entire fund.

Procter & Gamble, the consumer product group, was recently obliged to take a dollars 102m charge to cover a bad bet on the direction of interest rates.

The American concerns are likely to come to a head on Wednesday, when a congressional report on derivatives, commissioned two years ago, is to be released. It will recommend sweeping powers for the Securities and Exchange Commission to oversee unregulated players, notably the subsidiaries - known as derivatives products companies - that have been established by securitiies firms, financial service groups, oil companies and insurance companies.

Those who sell derivatives as agents would be required to ensure that their products are appropriate for the buyers. New accounting standards would expand disclosure of a company's derivatives positions, and the SEC would be allowed to monitor how individual corporations use the instruments. Minimum capital standards would be also established for the counter- parties they deal with.

The proposals are certain to arouse intense opposition from those who feel that new regulation will hurt business without reducing the market's risks. Last week saw a parade of former regulators - among them the former Fed governor Gerald Corrigan and former SEC chairman Richard Breeden - arguing that there was little danger in the market.

'There is far less risk today than in the past of something happening,' Mr Corrigan told a congressional committee last week.

In the UK, the Bank of England takes a leading role in this area through its supervision of the banks, which perform a key role in the derivatives market. It does not want to launch any new structures to deal directly with the derivatives market. It wants to continue its traditional methods of examining the risks to the UK banks, and deciding whether they need to strenghten their capital ratios as a buffer to risk.

The Bank is sceptical of suggestions that derivatives should only be traded on recognised markets. Liffe, for instance, is a recognised market, but London's multi-billion-pound futures and options market is not. Much futures and options swaps business is bilateral, for instance, not passing through any market at all.

A report into managing derivatives risks for companies and fund managers is published today by the accountants Ernst & Young. The report, which argues against new regulatory structures for the market, was prompted by the huge derivatives-related losses incurred by the likes of Volkswagen, Allied- Lyons, Showa Shell, Metallgesellschaft and Codelco.

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