Derivatives Plan Leaves Open Question of ‘Naked’ Default Swaps
By Dawn Kopecki and Robert Schmidt
July 30 (Bloomberg) -- A legislative outline of a new U.S. regulatory regime for the $592 trillion over-the-counter derivatives market leaves open for debate the pivotal issue of whether to ban so-called naked credit-default swaps.
House Financial Services Committee Chairman Barney Frank and Agriculture Committee Chairman Collin Peterson plan to discuss their proposal at 11 a.m. in Washington today. A three- page summary shows lawmakers have yet to agree on whether to outlaw derivatives where the buyer doesn’t own the underlying asset, or to determine disclosure rules and trading limits.
At a minimum, hedge funds and other companies using credit- default swaps would have to report to regulators any short positions related to those contracts, according to the proposal. The bill, which may change as it works its way through the two committees and the House floor, includes most of what the Obama administration has been pitching to rein in the derivatives market, including clearinghouses and margin requirements.
President Barack Obama’s plan to regulate derivatives is part of a wider overhaul of financial industry rules meant to prevent any repeat of last year, when the collapse of Lehman Brothers Holdings Inc. and American International Group Inc. froze credit markets and worsened the recession.
The proposal by Frank, a Massachusetts Democrat, and Peterson, a Minnesota Democrat, would require most derivatives to be traded on an exchange or sent through a clearinghouse with “significantly higher” capital and margin requirements.
“As long as everybody has to put some money up and we have tight oversight, we can have a strong bill,” Peterson said in an interview earlier this month, referring to Obama’s call for capital and margin requirements.
Short Positions
Credit-default swaps do “perform a useful function” in the economy, Frank said in a July 23 interview on Bloomberg Television. There may be “alternatives to banning naked credit- default swaps” if most derivatives are moved to a regulated exchange, he said.
“If we can get rules where almost every derivative is traded on an exchange, and those that aren’t because they are just too unique” are backed by extra capital, he said, “then that may do it.”
Some lawmakers and regulators have said they are looking more closely into whether credit-default swaps were manipulated by short sellers to spread false rumors about financial companies such as Lehman last year to drive down stock prices.
The proposal also sets up a Financial Services Oversight Council to resolve disputes between the Securities and Exchange Commission and the Commodity Futures Trading Commission.
Underlying Debt
Credit-default swaps are derivatives that were created primarily to protect lenders and bondholders from company defaults. A short position is an investment in which the trader tries to profit by betting a stock price will fall. Naked contracts or positions are those in which the buyer doesn’t own the underlying asset or stock on which the trading is based.
As much as 80 percent of the $26.4 trillion credit-default swap market is traded by investors who don’t own the underlying debt, according to Eric Dinallo, who stepped down this month as superintendent of the New York State Insurance Department.
Derivatives are contracts used to hedge against changes in stocks, bonds, currencies, commodities, interest rates and weather.
To contact the reporters on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net; Robert Schmidt in Washington at rschmidt5@bloomberg.net.
Last Updated: July 30, 2009 09:34 EDT |
