WASHINGTON -- Bank regulators and market participants gave conflicting reasons for opposing a derivatives bill yesterday at a hearing, where sparks flew when a sponsor of the measure accused an industry official of misrepresenting its provisions.
The bill, which was introduced in May by Reps. Henry Gonzalez, D-Tex., and Jim Leach, R-Iowa, calls for federal regulators to establish comprehensive and consistent standards for banks' derivatives activities.
Banking regulators, testifying before the House Banking subcommittee on financial institutions supervision, regulation, and deposit insurance, said the bill is unnecessary because it would not provide them with any new regulatory authorities.
"It probably wouldn't add much because it is pretty much what we are doing now," said Eugene Ludwig, comptroller of the currency. "It's not that it's harmful."
The regulators worried that by statutorily codifying what they are doing now, the bill would limit their flexibility to regulate the rapidly growing derivatives market in the future.
Derivatives market participants, however, said that the bill would impose new standards for derivatives that would increase costs and reduce the availability of derivatives products.
"By urging bank regulators to establish new principles and standards relating to, among other things, capital, accounting, disclosure, and suitability for banks and bank affiliates engaged in derivative transactions, [the bill] would subject such institutions to unnecessary burdens with unintended and potentially damaging effects on our financial system," Mark Brickell, a vice president at J.P. Morgan & Co. who was representing the International Swaps and Derivatives Association, said in a written statement.
The incongruity of the two stances of the regulators and market participants clearly perplexed subcommittee chairman Rep. Stephen Neal, D-N.C.
"If the bill doesn't require the regulators to do anything that they're not doing now, what's wrong with it?" he asked.
One concern, Brickell said, is that the bill calls for new capital requirements for derivatives when internationally agreed upon capital requirements have been in place for swaps since 1988.
Another concern, he said, is that the bill calls for regulators to impose a "suitability standard" on derivatives "that is not applied to any other area of finance" and that would "put all of the burden on banks" to make sure customers entered into appropriate derivatives transactions.
But Brickell soon found himself in a heated exchange with Leach, the top Republican on the banking committee, who was incensed at Brickell's remarks about the bill at the hearing and in a story in the American Banker on Monday.
Leach began by chiding Brickell for continuously referring to swaps in his comments even though the bill deals with a variety of derivatives products.
He then accused Brickell of repeatedly overstating and misrepresenting the bill's provisions.
"Unlike what you stated ... there is no capital standard for swaps in this bill. And to say that is a massive misreading of the circumstances," he said.
Brickell told the American Banker, a sister publication of The Bond Buyer, that the bill's suitability provision "introduces an undesirable element into the banker-client relationship" and could make banks liable for any losses from derivatives they sold customers.
"That is a very powerful statement and one that is false," Leach said. "What section of the bill is this in? I don't recall putting it in. It strikes me as abhorrent to my own views."
Leach said that the bill's provision on suitability would be no different than guidance issued by the Office of the Comptroller that requires banks to ensure the derivative products they sell are suitable for their customers.
"If you're going to be a constructive engager in making recommendations to this Congress that carry weight, I would recommend that you state valid observations, said Leach, adding "this is an invalid observation."
Leach also challenged Brickell for telling the American Banker that derivatives "can serve as a supplement to capital."
"I've never heard of a derivative product that adds to capital," he said.
Brickell said that a purpose of capital is to cushion a firm from business or financial risk, and derivatives provide protection against financial risk.
But Leach countered: "That's not a supplement to capital; it's a technique to protect whatever capital exists."
Brickell said he got the idea from a Harvard economics professor.
Leach said that most of the provisions in the derivatives bill were derived from the suggestions and recommendations of federal regulators and derivatives market participants like J.P. Morgan.
Brickell told subcommittee members that his greatest overriding concern about the derivatives bill is that it singles out derivatives and does not cover other kinds of financial products that can entail similar risks.
But Leach scoffed at Brickell, telling him derivatives "are new, they are off balance sheet, they are a totally different dimension [from traditional stocks and bonds], and your bank has been in the lead in suggesting that."
"You're sending a signal that you think something is wrong with this activity and the way that it is regulated," Brickell said.
But Neal told Brickell that derivatives already have a bad reputation, mostly because of the widely publicized losses of market participants.
Neal suggested the bill might help the derivatives market by sending the message that regulators are doing what they need to do to oversee derivatives.
After the hearing, Leach said he may urge the authors of the bill to tinker with some of its provisions. He said during the hearing that the suitability provision is "too vague" and "needs to be tightened." The subcommittee will mark up the bill, but not next week, he said.