Experts on the Future of the SEC, Part 5

4. Regulate OTC derivatives!

According to Hazen, “the relevant regulatory failure was the failure to regulate over-the-counter derivatives.” These markets were, in his words, “an accident waiting to happen.” Fried agrees that there should be “more transparency in that market.”

In 1999 Congress passed, and President Clinton signed, the Commodity Futures Modernization Act of 2000 (PL 106-554, 7 USCA 7a-1 et seq). The CFMA, implementing recommedations made by the President's Working Group on Financial Markets, contained provisions exempting certain derivatives, including credit default swaps, from regulation by the SEC or the CFTC. As Chairman Cox put it: in this “regulatory black hole” grew a market larger than, “the GDP of every nation on earth.” The Depository Trust & Clearing Corporation (DTCC) argues that the OTC derivatives market is only half the size Cox claims it is because he counts each transaction twice, but even using the DTCC's math we're talking about a 35 trillion dollar market.

The black hole is beginning to fill with band aids. The State of New York would classify credit default swaps as insurance and regulate the piece of the market written by New York-chartered insurers (approximately 60%). DTCC recently announced the creation of a central clearing facility for OTC derivatives and a database containing information about the largest transactions. Professor Hazen called central clearing of OTC derivatives the “minimum” regulation necessary.

DTCC may be trying to address Senator Tom Harkin's stated intention (Bond Buyer, 10/16/08, 2008 WLNR 19639053) to create a CFTC-regulated exchange for OTC derivatives.