WASHINGTON - Federal Reserve Board Governor Susan M. Phillips said yesterday that the Fed is developing a "supervisory letter" that will advise banks and bank examiners bout what risk management practices and controls banks should adopt for derivatives activities.
In a related matter, Phillips told reporters that she has some concerns about Rep. Jim Leach's call for legislation to establish an interagency group that would be charged with developing uniform standards for derivatives products .
Phillips made the comments during and after a speech to Women in Housing and Finance here.
In her remarks to the group, Phillips said she is pleased with the flexibility in recent guidance on derivatives risk management practices that the Office of the Comptroller of the Currency released for banks with federal charters.
But in responding to reporters' questions later, she declined to say how closely the Fed's supervisory letter will track the OCC guidance.
One of the controversial aspects of the OCC guidance is the requirement that banks determine whether derivative products are appropriate for customers. Phillips said in her speech that the Fed is "field testing" a similar requirement.
Leach, R-Iowa, the top Republican on the House Banking Committee, has said that he plans early next year to introduce a legislative proposal calling for an interagency group to be formed to set uniform standards that would apply across the board for derivative products.
Phillips said she had concerns about Leach's proposal after being questioned by a reporter.
"I think we're going to have to look and see the specifics of his bill when he puts it together because I don't quite know how it would work," she said.
Phillips said she agrees with other bank regulators who have raised questions about whether it is possible to focus the regulation of derivatives on products rather than on the institutions involved in them, as Leach has suggested.
Douglas E. Harris, senior policy adviser to the Comptroller of the Currency, has said that one of the problems with regulating derivatives by product is how to define the various products. Federal regulators and other derivatives experts may disagree about how to define various derivative products, Harris said.
In her speech, Phillips also said the Federal Reserve Board plans to take final action early next year on a rule that will eliminate the uncertainty about the legal enforceability of netting agreements in the United States between certain affiliates of securities firms and insurance companies that are active derivatives dealers, and between banks and other entities.
Netting agreements allow institutions in financial trouble to aggregate and take the net of all of the derivatives payments they owe or are owed by each counterparty.
Phillips said that the Fed is concerned about the systemic risks associated with derivatives, whereby the failure of a major derivatives dealer could have disastrous consequences for other firms that would spill over into other financial markets.
But she said that these concerns should not overshadow the critical use of derivatives to reduce risks for banks, broker-dealers, and other firms.
Phillips said she is "puzzled by the attention and concern that has been focused on derivatives" given that most derivative products are either forwards, futures, options, or combinations of such products that have been around, in some cases, for up to two hundred years.
