WASHINGTON -- Federal regulators warned yesterday against overreacting to fears about derivatives and said they have the tools needed to regulate derivatives activities.
The regulators included Frank Newman, the Treasury Department's undersecretary for domestic finance, who said concerns about derivatives risks are "overblown," and J. Carter Beese, a commissioner with the Securities and Exchange Commission, who said federal agencies "are cops on the beat" with regard to derivatives.
Their remarks at a derivatives conference here came as the Treasury's Office of the Comptroller of the Currency published guidelines to help national banks put in place the "no surprises" risk management policy for derivatives activities that Comptroller Eugene A. Ludwig called for last month.
The guidelines, which are contained in Banking Circular 277, require among other things that bank managers assure that credit authorization for derivatives activities are provided by bank officials that are not involved in trading.
"This is clearly a new obligation we're imposing on derivatives dealers," Douglas Harris, a senior policy adviser to the comptroller, said in describing the guidelines to those attending the derivatives conference, which was sponsored by the Commodity Futures Trading Commission.
Harris said that while the guidelines will help banks with derivatives risk management, "we're of the view that the credit and market risks of these products are less than other on- and off-balance sheet items" for banks.
Harris' comments echoed those of Newman and Beese.
Newman said that some market observers worry that derivatives are too complex and put firms and the financial markets at risk, but said, "based on what we now know, I believe that concerns that derivatives could perpetrate a financial melt-down are overblown."
Newman said commercial banks are involved in the derivatives markets in a variety of ways. They may use derivatives to hedge their own business risks. They may act as dealers and enter into a swap to help a customer hedge its business risk. They may be indirectly involved in the market when lending money to derivatives participants.
"I think it is important to emphasize that derivatives are both a potentially profitable activity for financial institutions acting as dealers and a useful risk management tool," even though they may pose challenges for government regulators trying to understand them, Newman said.
The government actually has been trying to remove impediments to the derivatives market for years, he said.
The SEC's Beese, scoffing at the market observers calling for restrictions on derivatives, ticked off a handful of securities and bank regulatory agencies that he said "all have rigorous regulatory regimes" that must be adhered to by derivatives participants.
"Our challenge going forward is to coordinate our efforts so that we have an adequate understanding of the aggregate size of the market and properly identify" the potential risks that exist, Beese said.
Newman endorsed the futures commission's call for an interagency council to coordinate regulatory efforts on derivatives. He said that while no changes in the regulatory structure for derivatives is called for at this point, if they are in the future, the government might consider the regulatory regime for government securities. In this regime, one agency issues rules for brokers and dealers, but other agencies of jurisdiction enforce the rules.
Meanwhile, Clifford Griep, executive managing director of the financial institutions department at Standard & Poor's Corp., said that "the risks related to derivatives seem fairly opaque." Griep said that while credit-rating agencies want to understand the risks, returns, and liquidity implications of derivatives activities, "I don't believe public financial statements enable us to assess any of those things" to any significant degree.
Griep said, however, that industry officials appear to be addressing these issues, pointing to the risk management and accounting recommendations made by the the Group of Thirty, a group of international financial experts.
Halsey Bullen, a project manager at the Financial Accounting Standards Board, said new industry accounting guidelines scheduled to take effect next year will force swaps dealers to more accurately report their exposures from swaps transactions. Some swaps dealers, he said, have been netting or offsetting all of their assets and liabilities from all of their swaps contracts. But under the new guidelines, dealers will only be able to net swaps payments with individual counterparties, and only if they have entered into netting agreements with them.