WASHINGTON - The top Republican on the House Banking Committee indicated yesterday that he will issue a report recommending that federal agencies take steps to ensure that derivatives products are equally regulated.
Rep. Jim Leach, R-Iowa, told reporters at a derivatives conference here that the report will be issued within a week. The conference was sponsored by the International Swaps and Derivatives Association.
At the same time, E. Carter Beese, a commissioner at the Securities and Exchange Commission, told those attending the conference that the industry and SEC must do more to improve accounting standards for participants in the derivatives market.
Beese called on market participants to voluntarily adopt accounting standards that better reflect how their derivatives activities affect their finances.
The financial statements of derivatives participants "are, for all intents and purposes, opaque," said Beese. "For the first time in recent memory, you can't assume that by looking at a firm's balance sheet you can adequately understand their business."
Leach told reporters that the report he plans to issue will be based, in part, on agency responses to a questionnaire and will contain a series of recommendations and "perhaps a legislative proposal or two" aimed at improving federal oversight of derivatives activities.
Leach did not specifically describe the recommendations to be made in the report, but said he believes that an interagency group is needed "to assess different kinds of products to make sure there's comparable regulation."
He said the interagency group that he envisions would be different from the groups proposed by the Office of the Comptroller of the Currency and the Commodities Futures Trading Commission.
"We're going to be designing it a little differently and then suggesting how we'd like to see it put together," he said.
Leach told conference participants that he believes the entire approach to regulating derivatives should be reoriented toward products rather than the institutions that participate in derivatives activities.
Under this approach, derivatives "could be regulated under a framework similar to the federal securities law where regulatory standards exist for securities products, regardless of the type of issuer," he said.
Leach is concerned, for example, that insurance companies such as American International Group Inc., whose derivatives products group is one of the largest players in the municipal and taxable swap markets, is not subject to the same federal regulatory requirements as other swap market participants. AIG and other insurance companies are subject to state, not federal, regulation.
At the same time, Congress and federal regulators must be cautious in any action taken on derivatives and must recognize that such products help firms manage risks and guard against market volatility, he said.
A strong case can be made for the Treasury Department to use derivatives for hedging purposes, Leach said. "The U.S. Treasury today may be assuming a greater risk in its current efforts to shorten maturities of U.S. borrowing than it would be in using derivative products for financial management purposes."
Leach said industry figures show only $358 million in counterparty losses to swap dealers has been reported over a 10-year period and that half of those losses came from a single set of transactions in the United Kingdom.
The figure is equivalent to "a mid-level credit loss at one of the many [thrifts] for which Congress has already appropriated over $100 billion in loss funds," he said.
A study by David S. Berry, director of research for Keefe, Bruyette & Woods, shows that quarterly derivatives trading losses were posted only four times during a period of more than 10 years - once by J.P. Morgan and three times by First Chicago. Those losses totaled $19 million, but when compared to the $35.9 billion in derivatives earnings reported, represent a 2,000-to-1 profit-to-loss relationship, Leach said.
Leach noted that industry officials have reported that a $6.25 trillion industry for derivatives has developed among the nation's top 50 banks. The net credit exposure for the banks is $90 billion, he said.
He said he is worried about derivatives being used for speculative activities, noting that there is a fine line between hedging and speculation.
Leach said the industry must "realize the dangers" of speculative activities and "discipline itself" and "exercise caution," particularly if it "wishes to avoid irrational governmental constraints.'
Derivatives activities "must be examined in the context of the decade of the 80s where America overleveraged itself with junk bonds, junk real estate, junk [thrifts]" and junk debt from less developed countries, he said.
Meanwhile, Beese sought to clarify his position on derivatives in light of the press coverage of a House Banking Committee hearing last week. He said that his message at the hearing was not "don't worry, be happy," but rather that the SEC "has the tools necessary to police this market" and is "committed to vigorously using these tools."
Beese said that information the SEC has collected from 250 broker-dealers and 700 significant affiliates shows that the notional amount of their derivatives activities is about $4 trillion. The total replacement cost for their derivatives contracts or products is about $18 billion, he said.
Beese commended the Group of Thirty's recent recommendations for improved risk management of derivatives activities, but said the industry must go further. Senior management, he said, must do more than pay attention to firms' derivatives activities. They "must develop a thorough understanding of the products, the risks their firms assume because of this activity, and the manner in which those risks are managed and controlled."