WASHINGTON -- The top Republican on the House Banking Committee said yesterday he may introduce legislation in January that would mandate the creation of an interagency group to develop uniform regulations for derivative products.
Calling derivatives "the new wild card in international finance," Rep. Jim Leach, R-Iowa, talked about the possibility of legislation at a press briefing during which he released a 400-page report containing 30 recommendations for the federal agencies that regulate the derivatives markets.
"What this is is a definitive statement that Congress expects regulators to act. And if they fail to act, more comprehensive legislation is in the offing," Leach told reporters.
At the same time, however, Leach said the committee's minority staff is currently drafting "a general framework bill" that could be introduced in January, but that would be "tempered" by the response to the report.
Leach said the bill would incorporate the major theme of the report: the need to create an interagency commission to establish uniform rules that would apply across the board for derivatives products, dealers, and end users and that might eventually be adopted internationally.
The bill would ensure that insurance companies like American International Group Inc., a major swaps market player, would have to comply with the same regulatory requirements for derivatives as securities firms and banks, he said.
Leach acknowledged the bill would tread on the jurisdiction of Rep. John Dingell, D-Mich., the chairman of the House Energy and Commerce Committee, which oversees securities. The committee is expected to hold hearings on derivatives next year after receiving a General Accounting Office report on the matter.
But Leach said his intent is to work with Dingell and not to preempt him.
"This is not a bill designed for an internecine congressional jurisdictional kind of battle," Leach said.
He said that while he is "pleased" that the banking agencies have begun to work together on derivatives guidance, a more formalized process is needed to make the regulators more accountable.
The report released by Leach recommends that an interagency commission be formally established to create uniform capital, accounting, disclosure, and suitability rules that would apply to most dealers and end users of derivative products.
Also included in the report is a recommendation that federal regulators establish "minimum prudential practices" for municipalities and pension funds that may use derivatives.
In addition, the report calls on regulators to examine the need for mutual funds to provide investors with more information about their derivatives activities and the risks of those activities. It also says regulatory officials should consider industry-wide suitability rules for derivatives.
The report urges the Treasury to evaluate the benefits of using derivatives for hedging to improve the efficiency of its financial management practices.
Reaction to the report was mixed.
One derivatives industry expert who did not want to be named said the report's recommendations go way beyond those that have been made by the federal agencies and industry groups. The recommendations can for micro-management of financial institutions in some cases and could result in increased costs and diminished availability of derivative products, he said.
The report "is so sweeping in scope. He's talking about overhauling the existing regulatory framework by the time he gets down to recommendation #2," the official said. That recommendation calls for federal regulation of insurance company derivatives, which currently are only regulated at the state level.
Douglas E. Harris, a senior policy adviser to the U.S. comptroller, said the report's recommendations over all are "thoughtful" and "represent an honest attempt to address the risks inherent in engaging in derivatives transactions."
Harris said that while the Office of the Comptroller of the Currency endorses many of the recommendations, a few are "novel" and are "very clear departures from the recommendations made by the regulators."
He said, for example, that he is troubled that the report calls on regulators to consider writing rules to protect against systemic risk, that is, the risk that the failure of a large derivatives dealer or sudden market disruption would be disastrous and spill over to the other financial markets.
"We think the best protection against systemic risk is the adoption by each individual institution of proper risk management policies and procedures and controls on their interconnected risk positions" and on concentrations of risks, Harris said.
He also said that while he is pleased that the report urges other agencies to follow the OCC's lead in issuing guidance to ensure dealers assess whether derivatives are appropriate for customers, he is concerned about the report's recommendation that agencies consider enacting industry-wide suitability rules.
"Our guidance certainly doesn't go as far as being a suitability rule. And we don't think, at this point, there is any clear need for such a suitability rule or that it would be of benefit to the market participants," Harris said.
Such a rule could increase the likelihood that banks could be held liable for customer losses, he said.
Another concern, Harris said, is that the report seems to suggest that banks evaluate risks based on an unreasonably high confidence level that would take into account an unusually high number of unexpected occurrences.
Harris said the OCC does not see the need for legislation at this point.
J. Carter Beese Jr., a commissioner at the Securities and Exchange Commission, said the Leach report "makes a positive contribution to the derivatives debate by focusing on the benefits and regulatory challenges posed by the derivatives market."
Several of the recommendations, such as those on mutual fund disclosure and accounting, touch on areas of SEC concern, Beese said.
He said he is pleased the report emphasizes regulation and not legislation" and that Leach "put it exactly right when he said that legislation should be a backstop if the regulators fail to act."