WASHINGTON — The first steps to regulate financial derivatives got off to a rocky start Wednesday, with two of the four competing clearing houses going in different directions while regulators pressed for more stringent restrictions.
Testifying before a House Agriculture Committee hearing on the topic, Johnathan Short, senior vice president and general counsel of IntercontinentalExchange Inc., said ICE intends to create a limited-purpose bank, ICE U.S. Trust, to house a clearing house for credit default swaps. The bank would be subject to oversight by the Federal Reserve Board and the New York State Banking Department.
But Kimberly Taylor, the managing director and president of CME Group Inc.'s clearing house division, said it wanted to be subject to the Commodities Futures Trading Commission, because of its history of regulating other derivatives.
Officials from the Securities and Exchange Commission and the CFTC sought more power from lawmakers to oversee derivatives directly, including credit default swaps. Lawmakers raised concerns that clearing houses, in which participation is voluntary, did not go far enough to address concerns about the rapid growth of the $60 trillion swap market. They also raised issues about which agency would be best suited to oversee the products.
"I don't have a lot of confidence," in the Fed's ability to regulate derivatives, House Agriculture Committee Chairman Collin Peterson, D-Minn., told Mr. Short. "I have more confidence in the CFTC."
Mr. Short said his group was not trying to avoid CFTC jurisdiction. "We chose to establish ICE U.S. Trust as a limited-purpose trust company and a member of the Federal Reserve because we viewed the Fed as one of the leaders in this area."
He also argued that the Fed's position as a regulator of bank holding companies gave it the authority to require institutions it oversees to participate in a clearing house.
ICE and CME Group are each creating a derivative clearing house to act as a central counterparty in the trading of credit default swaps, contracts that insure against the default of debt. Though the industry and lawmakers back the creation of a clearing house, there seems to be little confidence that how the concept is being executed — Rep. Peterson mentioned a total of four efforts under way — would attract trading parties effectively and increase transparency.
Federal regulators want to go even further. Erik Sirri, the SEC's director of trading and markets, said it has seen evidence of market manipulation in the trading of swaps, though its investigations were limited to antifraud inquiries. Regular reporting requirements fall outside its jurisdiction. "The SEC is statutorily prohibited under current law from promulgating any rules regarding CDS trading in the over-the-counter market," he said. "The tools necessary to oversee this market effectively and efficiently do not exist."
Acting CFTC Chairman Walter Lukken proposed a five-point plan to increase the regulation of financial derivatives. He said a clearing house would be only the beginning of new controls and would have to be followed by the establishment of reporting standards and an increase in capital requirements for parties trading derivatives.
He also recommended requiring the trades to be kept on balance sheets, incentivizing or even mandating the use of the clearing house, and establishing global cooperation for all regulatory efforts. "We don't want to start squeezing the balloon and have this go elsewhere."
If the CFTC can regulate agriculture and energy derivatives, there should be no reason it cannot regulate financial derivatives, as well, Mr. Lukken said.
