Last Updated Jun 4, 2010 10:08 AM EDT
Under both the House and Senate bills, banks would be exempt from regulation for some derivatives deals with non-financial companies that use the securities for hedging purposes. But the upper chamber's measure provides fewer loopholes, along with requiring banks to wall off their swaps businesses in a separate unit. Broadening the legislation too much is a mistake, Gensler said in a speech on Thursday in New York:
Every exemption for financial companies creates a link in the chain between a dealer's failure and a taxpayer bailout. Every slice of the financial system that we cut out through an exemption could allow one bank's failure to spread like fire through the economy.He also offers a general litmus test for deciding how far the legislation should go in sheltering banks from the proposed regs. If a derivatives transaction in any way links two financial firms, it should take place within a supervised clearinghouse. Said Gensler:
In the over-the-counter marketplace, transactions stay on the books of the derivatives dealers often for many years. This enables dealers to become dangerously interconnected with each of their counterparties as we saw with AIG. Clearinghouses move the risk off of the books of the dealers and into robustly regulated central counterparties.That makes sense. Arguably the greatest threat to the financial system is the kind of inter-bank risk that brought the capital markets to a screeching halt in 2008. That's especially true if megabanks continue to dominate finance, as they're being allowed to under the reform package.
The goal of reform should be to move as many standard over-the-counter derivatives transactions into central clearing as possible.
As legislators work to meld the reform bills, it's also worth noting that banks are using the push to shield non-financial companies, municipalities and other firms that use derivatives as a fig leaf for weakening the rules. The vast majority of derivatives trading is for speculation, while only a small fraction are related to hedging.
For instance, in the market for "interest-rate swaps," the largest class of OTC derivatives, only nine percent of deals are between banks and commercial customers, according to the CFTC. Transactions between banks constitute 34 percent of these transactions, while 57 percent involve deals among dealers and other financial firms, such as hedge funds or insurance companies.
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