Leach explains his derivatives control bill.

In a speech last month to. what he acknowledged was a "deeply skeptical" audience at a securities industry conference, Rep. James A. Leach, R-Iowa, defended a bill he is cosponsoring to establish standards for the derivatives industry.

Rep. Leach said the bill, H.R. 4503, would create an interagency commission to establish accounting, disclosure, and suitability requirements, enhance the regulators' authority to supervise derivatives, expand the accountability of boards of directors and managers, and enhance the Federal Deposit Insurance Corp.'s ability to manage derivatives products after the insolvency of a financial institution.

But he said the bill, cosponsored by Banking Committee Chairman Henry B. Gonzalez, D-Tex., has been misunderstood.

As the debate regarding derivatives regulation proceeds, certain myths about H.R. 4503 have been propagated. For example:

1.) MYTH: The legislation would require the federal agencies to establish unnecessary and possibly conflicting principles and standards.

FACT: The legislation would do no such thing, as it allows the regulators to establish only those principles and standards they feel are necessary and effective.

The intention of the legislation is to coordinate the actions of the regulators, thereby avoiding, not promoting conflicting standards.

2.) MYTH: The legislation would require extensive and detailed accounting disclosures in call reports.

FACT: The legislation does not set forth new requirements for call reports, but only makes suggestions for such disclosures. The suggestions are based on such proposals as those by the FASB and the FFIEC.

3.) MYTH: The bill would impose a suitability standard on products that could lead to unwarranted litigation and application of securities law precedents to the derivatives markets.

FACT: The OCC [Office of the Comptroller of the Currency] has already issued a "appropriateness" standard in its Banking Circular 277, and other forms of suitability standards exist. The legislation allows the regulators to design any new suitability standard only as they see fit, and assumes that they will consider beforehand any such unwarranted consequences.

It would be expected that the OCC "appropriateness" standard would be the model for compliance with the bill's requirements.

4.) MYTH: The legislation could create competitive inequities for the banking industry.

FACT: The authors of H.R. 4503 were extraordinarily wary of setting specific regulatory standards in order to allow the regulators to enjoy the same flexibility to consider such factors as competitiveness when setting standards as they do without the legislation.

5.) MYTH: The legislation is overbroad in its definition as it extends beyond swaps and over-the-counter derivatives, and that "no one has evaluated the merits of the proposed legislation with respect to everything else."

FACT: The 900-page study prepared by minority staff to prepare for legislation was not limited to over-the-counter derivatives, and my intention all along has been to consider the derivatives market as a whole in order to foster cross-product, cross-industry, and cross-border standards for derivatives.

Listing specific derivatives to which standards should apply would be both imprudent and impractical in this rapidly evolving market.

6.) MYTH: The bill asks the federal bank regulators to do that which the Presidential Working Group on Financial Markets has already been asked to do.

FACT: We are not guaranteed that the working group will address each area we feel is necessary to address. Furthermore, the Working Group in not structured to receive direct input from the OCC and the FDIC, as is our legislation. The OCC and the FDIC have exhibited invaluable expertise in the area of derivatives, and their input is imperative.

In addition, certain things such as the development of cross-industry standards can only be done if there is a legislative mandate to empower the prospect.

In addition to regulatory standards, H.R. 4503 sets forth other meritorious and widely supported supervisory improvements, financial institution insolvency reforms, and international regulatory cooperation provisions not currently being addressed outside this legislation.

I continue to acknowledge that derivatives are invaluable tools that are being used prudently and effectively in a majority of circumstances, and that limited problems require constrained solutions.

Although more draconian legislation solutions have been offered to date, I am committed to maintaining a restrained and balanced approach to derivative regulation.

H.R. 4503 was carefully crafted to preserve the flexibility of regulators, while promoting the integrity of both the institutions under our jurisdiction and the financial markets in which they operate.

The case for framework legislation in the derivatives arena should thus not blithely be dismissed. Next Congress, the Banking Committee will likely work together with the Energy and Commerce Committee on issues related to the functional regulation of capital market activities, including Glass-Steagall reform and mutual fund practices. Derivatives will be considered in the context of this debate.

The question is not whether Congress should act, but how carefully it will.

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