Obama releases rules for derivatives
Exotic financial instruments have been largely unregulated
WASHINGTON – The Obama administration Thursday proposed a broad new framework for regulating the dark and complex world of over-the-counter derivatives, vowing to shine a light on the financial products behind the downfall of insurance giant American International Group Inc.
“There is widespread agreement that … derivatives, particularly credit default swaps, may have contributed greatly to the financial mess that we’re cleaning up now,” said Mary Schapiro, chairwoman of the Securities and Exchange Commission.
AIG had such a huge financial exposure to derivatives, especially credit-default swaps, that eventual losses turned the global insurer into the single biggest basket case in the nation’s financial bailout with federal commitments for $182.5 billion in aid.
The International Swaps and Derivatives Association, an industry trade group, estimated that there were about $403 trillion in outstanding derivatives at the end of last year, with credit default swaps making up about $38.6 trillion of that.
Credit default swaps essentially are insurance policies. AIG issued them to banks and other major institutions to cover potential losses on mortgage loans and other investments.
Because so little was known about the derivatives market, regulators were unable to foresee the problems that triggered the financial crisis last year, and holders of those derivatives panicked out of fear they would not be paid.
The plan would set new rules for all standardized derivatives, requiring their trades to go through regulated central counter-parties, or middlemen. All major derivatives dealers also would be subject to supervision and regulation, including reporting requirements and minimum levels of capital on hand. And trades of customized derivatives would have to be reported to regulated trade repositories that would make some aggregated data, such as trading volumes and open positions, available to the public.
Oversight would be shared by the SEC and the Commodity Futures Trading Commission, which would have increased powers to monitor the markets for fraud, abuses and signs of risk to the overall financial system. Congress must change some laws and enact new ones to allow more derivative regulation.