NEW YORK - The responsibility of minimizing risk in the trading of complex financial contracts known as derivatives should fall to those involved in the transactions, not to government policymakers, said Federal Reserve Governor Laurence Meyer.
"It remains for market participants to develop the systems that will best serve markets within the given legal framework," Mr. Meyer said in remarks prepared for a Fordham University conference Friday on derivatives and risk management.
The challenge for policymakers will be to keep their hands off as derivatives trading becomes more complex and widespread, he said. Derivatives are financial investments that rise or fall in value according to the performance of a commodity, currency, security, or other asset. They trade over the counter, not on exchanges, and generally are held by only the most sophisticated investors.
"Policymakers no doubt will be tempted to mandate cooperation on the part of market participants in an effort to hasten developments that they believe may reduce risk," Mr. Meyer said. "In adopting such a course, however, they risk pushing markets and market participants down inefficient and undesirable paths."
Mr. Meyer's speech largely echoed the views of Fed Chairman Alan Greenspan, who joined fellow regulators this month in urging Congress not to regulate derivatives. Mr. Meyer did not address the state of the U.S. economy or the Fed's interest rate policy in his text.
"Policymakers simply cannot dictate the details of risk management based upon assumed market developments," Mr. Meyer said. "In some instances, rather than mandating certain steps, policymakers might provide proper incentives for risk-reducing steps through capital requirements or disclosure regulations."
Mr. Meyer's remarks, like Mr. Greenspan's, expanded on a November report by the Fed and other regulators that was aimed at ending years of questions about rules for derivatives trading. The agencies studied everything from the futures market to the $4 billion of losses on derivatives and other investments by Long-Term Capital Management LP in 1998.
Congress plans to rewrite the Commodity Exchange Act, which regulates futures trading but expires this year. Leaders of the Senate and House Agriculture committees have said they are committed to rewriting the law within three months.
Lawmakers also have said they want to clarify laws regarding derivatives. Though derivatives are similar to regulated futures contracts, they are not governed directly by any U.S. securities, banking, or futures rules, and federal law is vague about whether they should be regulated and, if so, by whom.
This is an important issue for major banks and securities firms, which have billions of dollars tied up in derivatives, and for the Chicago Board of Trade and other futures exchanges, which view derivatives as unfair competition.