FUTURES PANEL DIGS IN HEELS ON SWAPS: BANKING PANEL WARNS IT TO BACK OFF REGULATING DERIVATIVES

Hints by the Commodity Futures Trading Commission that it may ignore pleas from the industry and other regulators and begin regulating over-the-counter derivatives markets could jeopardize thousands of swaps contracts, the chairman of the House Banking Committee says.

And financial industry representatives addressing a hearing on the issue earlier this month agreed that by floating the notion the commission has introduced legal and regulatory uncertainty in the derivatives markets.

Chairman Jim Leach said at the hearing: “A simple hint that a swap contract might be redefined could call into question the legality of thousands of swap contracts” around the world with notional values in the trillions of dollars. The I owa Republican has introduced legislation that would put the commission’s control of OTC derivatives on hold for a year, while the Treasury Department studies the issue.

(Mr. Leach said that despite the efforts of the Treasury, the Federal Reserve, the Securities and Exchange Commission and most industry representatives to get it to hold off, the futures commission has refused to rule out the possibility t hat it may regulate OTC derivatives. Derivatives are contracts with a value that depends on the value of underlying rates, indexes or assets. They are used for hedging against risk from interest rate and currency fluctuation and other fact ors and can multiply profit or loss by leverage.

The commission, in a “concept release” issued in May asking for comment on the matter, suggested that it might begin regulating derivatives that are not traded on exchanges. Mr. Leach said the document was “coated by suggestive offhand remarks by CFTC officials,” and “had the distinct flavor to participants in the market of costly new regulation. Care must be taken not to upset market balances in the guise of formal inquiries.”aimed at sowbellies

He noted that the futures commission — established primarily to oversee agricultural commodities markets — has less expertise in overseeing the financial area, including derivatives, than do banking and securities regulators. “We have t hree federal departments and agencies with more market expertise than the CFTC that take issue with the CFTC’s recent actions on OTC derivatives regulation,” he said.

Mr. Leach also scolded futures commission Chairman Brooksley Born, saying she had not responded to congressional efforts to reach a compromise between the agencies. “Instead of giving the courtesy of a formal response, the chairman sent a dismissive reply through the press,” he said. He accused the commission of using the issue in a power play against competing regulatory agencies.

The commission’s concerns about fraud in OTC derivative markets are “overblown,” Mr. Leach said, since “fraud is illegal whether or not a contract is a future, option, or security” or falls under any jurisdiction.

(Ms. Born, in a letter to the House Agriculture Committee, said the CFTC voted unanimously on Friday to call a temporary halt in its moves to regulate OTC derivatives until Congress reconvenes after the first of the year — “except as nec essary in an emergency.”)

In testimony before a House Agriculture subcommittee last month, Ms. Born defended her agency’s position, saying a reappraisal of its role in the derivatives markets is necessary in light of their tremendous growth and the mounting losses they have caused.

The notional value of contracts in interest rate and currency swaps and interest rate options was $28.7 trillion worldwide in mid-1997, up 13% from six months earlier, according to the most recent market survey by the International Swaps a nd Derivatives Association.

Financial industry officials agreed with Mr. Leach that the futures commission’s concept release has created uncertainty in the derivatives market. Dennis Oakley, a managing director of Chase Manhattan Bank, which at the end of March held derivatives with a notional value of $8.2 trillion and credit exposure of $35.4 billion, said that Chase is concerned that some of its fastest-growing products, such as equity and credit derivatives, would be declared void if they were to come under CFTC regulations.

He also said Chase may be forced to move its derivatives business to London, “where we don’t have the specter of legal jeopardy that has been raised by the CFTC.”

George James, a managing director at Morgan Stanley Dean Witter & Co., said the commission’s action “has U.S. and foreign market participants examining the validity of existing OTC derivatives and swap contracts executed under U.S. law.”

The CFTC’s concept release is in “direct contradiction to previous CFTC policy statements and its specific regulatory actions,” he said.

Mr. James added that Congress, and not an individual agency, should determine the appropriate regulatory framework for derivatives.

But not all derivatives traders are opposed to the futures commission’s suggestion. James Moore is president of DGM Investments Inc. in Greenwood Lake, N.Y., which uses derivatives in its $120 million worth of hedge and commodity funds. He says he has “no difficulty with the CFTC supervising off-exchange derivatives. The way things are going people are just screwing it up.”

“For some reason, people are rapidly attracted to the leveraged industries,” he adds, “and sometimes it’s people who are not as responsible as we’d like them to be.”