SEC Chairman Mary L. Schapiro appeared before the House Committee on Agriculture on September 22, 2009, to testify regarding the regulation of over-the-counter (“OTC”) derivatives. In particular, she spoke about the Over-the-Counter Derivatives Markets Act of 2009, which was proposed in August by the Department of the Treasury. Ms. Schapiro noted that the recent financial crisis had revealed serious weaknesses in U.S. financial regulation, including a lack of regulation of OTC derivatives.
Ms. Schapiro noted that the framework provided by the Treasury proposal is designed to achieve four broad objectives: (1) preventing activities in the OTC derivatives markets from posing risk to the financial system; (2) promoting efficiency and transparency of those markets; (3) preventing market manipulation, fraud, and other market abuses; and (4) ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties. However, she laid out several broad areas in which the proposal could be strengthened to further avoid regulatory gaps and eliminate regulatory arbitrage opportunities.
One of Ms. Schapiro’s suggestions was aimed at minimizing regulatory arbitrage and gaming opportunities by regulating swaps like their underlying “references.” Ms. Schapiro noted that gaming, or regulatory arbitrage, possibilities abound when economically equivalent alternatives are subject to different regulatory regimes.
Under the Treasury’s proposal, regulatory responsibility for securities-related OTC derivatives would be divided between the SEC and the CFTC. Regulatory responsibility for other OTC derivatives would be given to the CFTC. Ms. Schapiro noted that although this could help to eliminate differences within the broad and varied world of “swaps,” it could result in significant regulatory differences between “swaps” products and the currently “regulated” securities and futures products. These regulatory differences could perpetuate existing regulatory arbitrage opportunities that encourage the migration of activities from the traditional regulated markets into the differently regulated swaps market.
Ms Schapiro suggested that the Treasury’s proposal be modified so that all securities-related OTC derivatives be regulated more like securities; and commodity and other non securities-related OTC derivatives be regulated more like futures. This would result in securities-related OTC derivatives and the underlying securities being regulated consistently. Ms. Schapiro suggested that Congress could implement this strategy by extending the federal securities laws to all securities-related OTC derivatives and extending the Commodity Exchange Act to all commodity-related and non-securities related OTC derivatives. This could significantly reduce the arbitrage opportunities between the regulated markets (securities or futures) and the differently regulated swaps market.
A complete copy of Ms. Schapiro’s testimony before the House Committee on Agriculture can be found here.