WASHINGTON -- The Securities Industry Association is urging the SEC to allow securities firms to self-regulate their over-the-counter derivatives business.
The proposal for industry self-regulation, which would allow broker-dealers to continue conducting swaps and other over-the-counter transactions in subsidiaries that are not regulated by the Securities and Exchange Commission, was outlined in a recent letter to Brandon Becker, director of the SEC's division of market regulation.
Under the industry proposal, securities firms would voluntarily provide the SEC or other regulatory agencies with periodic reports on various aspects of their derivatives activities. The firms would also work with the SEC or other regulatory agencies to come up with capital, disclosure, and accounting standards as well as guidelines to address investor protection concerns. The standards and guidelines would be complied with on a voluntary basis.
SEC officials could not be reached for comment on the proposal.
But one key congressional staff member who was familiar with it said: "I'm not sure how effective a voluntary system of guidelines would be because people could choose whether or not they would comply with them."
The industry's proposal for a self-regulatory regime comes as some regulators and lawmakers have been calling for, or raising the specter of increased federal regulation of over-the-counter derivatives.
SEC Commissioner Richard Roberts, in a speech at a conference in New York City last Thursday, suggested that derivatives products companies should be regulated and made subject to the SEC's capital requirements.
Howard Kramer, the SEC's associate director of derivatives and exchange oversight, said at another conference in New York City on April 27 that the SEC has not ruled out the possibility of defining swaps and other derivatives as securities that are subject to SEC regulation.
Reps. Henry Gonzalez, D-Tex., and Jim Leach, R-Iowa, are nearing agreement on a draft bill that would require the bank regulatory agencies to step up their efforts to regulate bank's derivatives activities. Eugene Ludwig, comptroller of the currency is considering restricting national bank's used and proprietary trading of exotic derivatives.
And the General Accounting Office is expected to release a report in two weeks that highlights the gaps in the regulation of derivatives.
But the association's letter, which was written on behalf of eight of the nation's largest securities firms, said that because the Securities Exchange Act of 1934 "does not provide a useful model for developing a supervisory mechanism for the dealers in this market, we are proposing a framework based on the voluntary participation of market participants in partnership with the SEC and other appropriate regulators."
Specifically, the proposal calls for securities firms to provide the SEC or other agencies with periodic reports on their derivatives activities so that the regulators can evaluate the risks undertaken by the firms and the methods they use to control those risks.
The reports would include information about: positions hedged in exchange-traded instruments, large concentrations of unsecured credit exposures, the adequacy of internal systems and controls, funding arrangements, and how a firm determines the adequacy of its capital in relation to the risks incurred from its derivatives activities. Additional information would be provided to the SEC on an "as needed" basis.
The firms would work with the SEC to develop capital standards based upon dealers' own risks evaluation models. The models would be subject to verification and stress testing, the letter said.
The firms would also work with the SEC to develop guidelines to address investor protection concerns, the letter said, because "individual investors, and others who may have a right to rely on dealers to recommend only appropriate investments, should be able to have similar protection with respect to [over-the-counter] derivatives."
The firms would undertake an initiative to collaborate with the SEC and the accounting profession to "overhaul" the financial statements of derivatives dealers and end-users "to provide truly useful information" about derivatives activities, the letter said.
Another project would be for the firms to work with regulators to develop legislative or regulatory measures designed to reduce the uncertainties about the legal status of over-the-counter derivatives transactions and other financial products, the letter said.
The letter was signed by Jeffrey L. Seltzer, chairman of the association's swap and over-the-counter derivatives products committee, and was written on behalf of Bear, Stearns & Co.; CS First Boston; Goldman, Sachs & Co.; Kidder, Peabody & Co.; Lehman Brothers; Merrill Lynch & Co.; Morgan Stanley & Co.; and Salomon Brothers.
