Regs for swaps, other derivatives debated

Regulators and members of the futures industry convened before the House Agriculture Committee this week to debate the regulation of credit default swaps and other derivatives.
The Feb. 3-4 legislative meeting was the first in the new year to review a draft bill of the Derivatives Markets Transparency and Accountability Act of 2009.
The proposed rule attempts to shed light on over-the-counter derivatives transactions by subjecting them to record-keeping and reporting rules determined by the Commodity Futures Trading Commission and charging the regulator with determining whether OTC agreements can disrupt the market or keep prices from reflecting supply and demand.
Most importantly, the rule would ban parties from entering into naked credit default swaps, transactions in which the participants don’t bear the risk of financial loss. In a CDS transaction, a buyer pays a premium to a seller and receives protection if an underlying financial instrument defaults. In that context, these derivatives have been compared to insurance.
Though the parties present at the hearing, including the Managed Funds Association of Washington and the National Conference of Insurance Legislators of Troy, N.Y., pointed to the need for greater transparency in the derivatives market, opponents fear that the rule would upend the CDS market.
The MFA is against the provision that would make it illegal for market participants to use naked credit default swaps, as it would keep banks and other investors out of the market.
“This provision would cripple the CDS market by making investment capital illegal and removing liquidity providers,” Stuart J. Kaswell, executive vice president of the MFA, said in his testimony. “Without investment capital in the market, market participants wishing to hedge their position through a CDS would find few, if any, market participants to take the other side of the contract.”
Proponents of CDS regulation include the National Cotton Council of America of Cordova, Tenn., which was represented by Gary Taylor, chief executive of Cargill Cotton Inc., also in Cordova. He argued that speculative investment funds and OTC transactions have flooded the futures markets, disrupting the futures and markets of energy and agricultural commodities. Mr. Taylor supports position-size limitations on hedgers, who can purchase large long and short positions in the futures markets.
Finally, New York Assemblyman Joseph D. Morelle testified on behalf of NCOIL, calling for state CDS regulation, as his group feels that the swaps are “a species of insurance,” and thus authority over them should go to state legislators and insurance regulators.