WASHINGTON -- Legislation that would close the regulatory gaps for derivatives is not needed and could hurt the derivatives markets, the Securities Industry Association told Rep. John Dingell, D-Mich., this week.
"We believe that an effort to mandate solutions in an environment in which the problems have not been clearly identified, and solutions are ill-defined and do not enjoy broadbased support, is a recipe for future problems," the association's swap and over-the-counter derivative products committee said in a July 31 letter to Dingell.
Dingell, who chairs the House Energy and Commerce Committee, had asked the association to detail its views about the derivatives report that was issued by the General Accounting Office in May.
In that report, the GAO said that derivatives pose significant risks and that Congress should enact legislation soon to subject the unregulated derivatives affiliates of securities firms and insurance companies to Securities and Exchange Commission regulation.
But in its letter to Dingell, the SIA committee said that the GAO report did not contain any information that would support that conclusion or recommendation.
"In our view, the report's conclusions as to the risks presented by the unregulated derivatives activities of broker-dealer affiliates are not borne out by its empirical findings, or by the empirical findings of other regulators who have conducted an examination of these issues," the SIA committee said.
The GAO's call for immediate legislation to regulate these activities is "extreme," the committee said, and was made without any "empirical" or analytical support or any analysis of the consequences on "an evolving market that is widely acknowledged to be well-managed and responsive to policy concerns."
The committee reminded Dingell that federal regulators have all concluded that unregulated derivatives affiliates do not pose a significant risk to their broker-dealers, the Securities Investor Protection Corp.'s insurance fund, or banks with federal deposit insurance. The regulators have concluded that new regulations are not needed, the letter said.
"We believe the public policy case for derivatives-specific regulation of broker-dealer affiliates has not been made," the committee said.
The committee faulted the GAO report for not addressing the "prospects" for derivatives market participants and federal regulators to work together to resolve derivatives concerns.
Committee members "are currently engaged in an extensive dialogue with SEC staff to address issues of potential concern and are committed to assisting the SEC and other responsible regulators in addressing issues that need to be resolved," the letter said.
The committee said it is working with the SEC to improve the commission's access to derivatives information and to ensure that derivatives dealers and their affiliates have enough capital on hand to support any risks they may be incurring.
The committee also complained that the GAO report failed "to consider the possible pitfalls of pursuing legislative solutions in the current environment."
Derivatives and the systems to monitor and manage their risks are evolving so rapidly that new regulation would "risk freezing the development of these new approaches to risk management in mid-stride," the committee said.
Moreover, the committee said, there is "no consensus" about what new regulations are needed.
"Proceeding With regulation at this time may therefore launch a premature process full of disagreement and discontinuity, with a real risk that rules will become an obsolete hindrance to best practice and optimal economic activity or [will] need to be revisited with such frequency as to pose a serious threat to market stability," the letter said.
The committee told Dingell that it "recognizes that it may not be possible to dispel completely the concerns that the failure of one of the largest derivatives dealers could have consequences for other organizations or for markets generally that warrant public concerns."
But the major derivatives dealers have taken steps to assure that they have the systems in place to manage their derivatives risks and are working with regulators to address concerns, the committee said.
Turning to the subject of financial disclosure, the committee agreed that there is a "pressing" need to improve the financial information disclosed by derivatives market participants.
However, the committee criticized the Financial Accounting Standard Board's. proposals for disclosure standards, which it said would be "unique to derivatives."
"We believe that such an approach ... would be costly to develop and could result in disclosure that is ineffective or seriously misleading," the committee said. Distinguishing between specific types of financial instruments would not be meaningful, the committee said.
Disclosing revenues or other performance measures for certain types of products, the committee said, "can create the very confusion and concern that improved disclosure is intended to avoid."
The committee also complained about calls for sales practice standards for derivatives.
"In our view, it would be inappropriate to superimpose on this market concepts of suitability drawn uncritically from the securities market," the committee said.
"In addition, affiliates of securities broker-dealers would be placed at a significant competitive disadvantage if they were to be subjected to standards of practice that are not appropriate to the Character of the marketplace and consistent among firms, including commercial banks, who are the leading dealers in the [over-the-counter] derivatives market," the committee told Dingell.
