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STATEMENT

OF

THE INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, INC.

BEFORE THE

COMMITTEE ON BANKING AND FINANCIAL SERVICES

UNITED STATES HOUSE OF REPRESENTATIVES

APRIL 11, 2000

This statement is submitted by the International Swaps and Derivatives Association, Inc. ("ISDA") to the Committee on Banking and Financial Services of the United States House of Representatives (the "Committee") in connection with the Committee’s April 11, 2000 hearings on the bill introduced on April 6, 2000, by Chairman Leach and cosponsored by Representatives LaFalce, Baker and Kanjorski entitled the "Over-the-Counter Derivatives Systemic Risk Reduction Act of 2000 (the "Risk Reduction Bill"). The Risk Reduction Bill implements certain aspects of the November 1999 Report of the President’s Working Group on Financial Markets on Over-The-Counter Derivatives and the Commodity Exchange Act (the "Report").

Overview

ISDA is an international organization and its more than 460 members include the world’s leading dealers in off-exchange principal-to-principal derivatives transactions (collectively "swaps transactions") that are the focal point of the Report. These dealer-members are among the principal customers of the futures exchanges that are regulated by the Commodity Futures Trading Commission (the "CFTC") under the Commodity Exchange Act (the "CEA"). In addition, ISDA’s members also include many of the businesses, financial institutions, governmental entities and other end-users that rely on swaps transactions to manage their financial and commodity market risks with a degree of efficiency and effectiveness that would not otherwise be possible. In accordance with the Committee’s request, the main focus of this statement is on the legal and regulatory environment in the United States for swaps transactions.

ISDA has consistently urged Congress to enact legislation to provide legal certainty for swaps transactions. "Legal certainty" simply means that parties (both dealers and end-users) must be certain that provisions of the swaps contracts they enter into will be enforceable in accordance with their terms. The CEA has been the principal source of legal uncertainty with respect to swaps transactions in the United States. For this reason, ISDA has actively supported legislation that would modernize the CEA to provide legal and regulatory certainty for all financial contracts.

ISDA welcomed release of the Report, which reflects an extraordinary consensus reached by the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve System, the Chairman of the Securities and Exchange Commission and the Chairman of the CFTC that Congress should enact legislation explicitly to clarify that swaps transactions generally are excluded from the CEA and thus ensure that swaps transactions are enforceable in accordance with their terms. As stated in the Report, ". . . an environment of legal certainty . . . will help reduce systemic risk in the financial markets and enhance the competitiveness of the U.S. financial sector". Indeed, as the Report noted, the failure to do so ". . . would perpetuate legal uncertainty or impose unnecessary regulatory burdens and constraints upon the development of these markets in the United States".

ISDA has followed with interest the regulatory initiatives being undertaken by the CFTC at the direction of its Congressional authorizing committees. ISDA appreciates the willingness of Chairman Rainer, his fellow Commissioners and the professional staff of the CFTC both to avoid regulatory measures that increase legal uncertainty and to explore opportunities to enhance legal certainty that are consistent with the recommendations of the Report and the CFTC’s administrative authority under the CEA. At the same time, however, ISDA remains convinced that only Congress can provide a comprehensive solution to the legal certainty issue and that the time to do so is now.

ISDA therefore welcomes and is supportive of the commitment of the Chairman, the ranking member and other members of this Committee to propose legislation based on the recommendations contained in the Report. While the Risk Reduction Bill would not directly amend the CEA to provide a statutory exclusion for all swaps transactions, it nevertheless represents a creative and constructive approach designed to provide legal certainty for swaps transactions, encourage technical innovation and remove the existing regulatory barriers to clearing. This legislation would reduce systemic risk and is consistent with the recommendations contained in the Report. It also is compatible with ISDA’s long-standing support for legislation to provide legal certainty, minimize systemic risk, encourage financial innovation and facilitate competition in the United States and abroad.

ISDA believes that the legal certainty provision of the Risk Reduction Bill covers an appropriately broad range of derivatives transactions entered into by any swaps dealer. ISDA applauds the breadth of this provision. ISDA notes, however, that the multilateral clearing provisions and the electronic trading provisions of the Risk Reduction Bill do not limit the applicability of the CEA or CFTC jurisdiction in the case of transactions involving nonfinancial commodities with finite supplies. ISDA believes that these provisions should be made applicable not only to swaps involving financial instruments, rates and indices, but also to swaps involving electricity, oil, gas and other physical commodities having highly liquid cash markets. ISDA notes that Chairman Leach has stated his intention to work with the Committee on Agriculture to implement recommendations in the Report that are primarily before that Committee. ISDA looks forward to working with all concerned to develop and enact broader legislation that would create legal certainty and an appropriate regulatory structure for clearing as well as electronic trading and other aspects of swaps activities.

ISDA also welcomes the interest of this Committee in issues related to regulatory structure. The laws of the United States should foster efficient, liquid and low cost financial transactions. Regulatory burdens that increase the cost or decrease the availability of swaps transactions and other risk management tools to businesses and other end-users should be imposed only in those cases where less burdensome means, including market discipline, have not proven to be effective.

Consistent with the foregoing, ISDA’s agrees with the recommendations in the Report that no legislative action should be taken to regulate swaps dealers as such. While the Report notes that only a small percentage of swaps transactions are entered into by otherwise unregulated swaps dealers, it must be emphasized that those swaps dealers that are now regulated either at the federal level (e.g., banks) or at the State level (e.g., insurance companies) are regulated by reason of their institutional nature and all of their transactions—not just their swaps transactions—are subject to supervision. No compelling case has been put forward for federal regulation of swaps dealers solely because of their participation in swaps transactions.

Likewise, and again consistent with the recommendations in the Report, no compelling case has been put forward for federal regulation of swaps transactions as such. Most of these transactions are entered into by sophisticated parties acting as principals. These parties have no need for special consumer protections and the transactions themselves typically serve no meaningful price discovery function and present little if any potential for manipulation.

The balance of this statement summarizes in greater detail ISDA’s views on the key recommendations of the Report, including those related to legal certainty, electronic trading and clearing of swaps transactions; the Treasury Amendment; hybrid instruments; the regulation of swaps dealers; and netting.

Legal Certainty for Swaps Transactions

Swaps transactions are effective tools that enable American businesses and other end users in each of the 50 States to manage the interest rate, currency, commodity, credit and other related risks that are inherent in their activities. In this way, businesses and other end users of swaps transactions are able to lower their cost of capital, manage their credit exposures, and increase their competitiveness both in the United States and abroad by focusing on their core areas of expertise. For example, if a business has floating-rate debt outstanding and is concerned that interest rates will rise, it can use an interest rate swap to create the same cash flow as a fixed-rate obligation. Similarly, if a business has the right to receive non-dollar revenues from a foreign-based affiliate, it can use a currency swap to hedge its exposure to fluctuating exchange rates. The United States has been a leader in the development of swaps transactions and American businesses were among the earliest to benefit from these risk management tools.

Unlike exchange-traded futures contracts, swaps transactions provide end-users with an opportunity to tailor the key economic terms of their transactions to their specific risk management needs. This almost limitless flexibility has led to the dramatic growth in the volume and diversity of swaps transactions. Thus, while the majority of swaps transactions relate to interest rates and foreign currency, there is increasing use of commodity, energy, credit, equity, weather and other types of swaps transactions.

The dramatic growth in the volume and diversity of swaps transactions is probably the best evidence of their importance to, and acceptance by, end users. It is no coincidence that the U.S. economy and the volume of swaps transactions both grew dramatically during the last decade.

One of ISDA's principal goals since its inception has been to promote legal certainty for swaps transactions. For example, ISDA has sought to establish (i) clarity concerning how swaps transactions will be treated under the laws and regulations of the U.S. as well as other countries throughout the world; (ii) certainty that swaps transactions will be legally enforceable in accordance with their terms and not subject to avoidance; and (iii) certainty that key provisions in swaps transactions (including netting and termination provisions) will be enforceable, even in the case of the bankruptcy of one of the parties. ISDA has supported legal certainty initiatives in the U.S. and abroad. In addition, ISDA has developed master documentation templates for swaps transactions that are today used in the United States and around the world by the vast majority of swaps participants for their transactions.

The central recommendation of the Report is that Congress enact legislation to provide legal certainty that swaps transactions will be enforceable in accordance with their terms. The importance of legal certainty cannot be overstated. Any uncertainty with respect to the enforceability of a swaps transaction presents an obvious and significant source of risk to the individual parties to the transaction. As the Report emphasizes, any such uncertainty creates risks for the financial system as a whole and undermines the U.S. role as a key global financial center. More importantly, as stated in the Report, "an environment of legal certainty . . . will help to reduce systemic risk in the financial markets and enhance the competitiveness of the U.S. financial sector." Finally, any legal uncertainty limits the realization of the powerful risk management benefits that swaps transactions provide to businesses and other end-users.

The CEA, the main source of legal uncertainty with respect to swaps transactions, generally prohibits off-exchange "futures" contracts, but it does not define the term "futures" contract. Thus, if a swaps contract were ever declared to be a "futures" contract, that contract could be declared illegal and unenforceable for failure to comply with federal law unless the transaction qualified for an exclusion from or exemption under the CEA, such as the Treasury Amendment exclusion or the administrative exemption for certain swaps transactions. For more than 10 years, Congress, financial regulators and others worked actively to preserve and promote legal certainty that swaps transactions are not appropriately regulated under the CEA. These incremental measures have fostered the rapid growth of swaps transactions as an essential risk management tool but have not eliminated all uncertainty or addressed obstacles to continuing innovations.

Concerns that the CEA may create legal uncertainty are neither academic nor speculative. In 1998, unilateral actions by the CFTC suggested that the CFTC might treat certain swaps transactions as "futures". Because, as stated earlier, off-exchange futures contracts that do not qualify for an exclusion from or exemption under the CEA could be declared illegal for failure to comply with federal law, this suggestion nearly shattered the settled expectations of the financial markets that United States swaps transactions were enforceable in accordance with their terms. The resulting uncertainty was particularly acute with respect to those categories of swaps transactions (such as swaps based on non-exempt securities) not eligible for the existing administrative exemptions from the exchange-trading requirement of the CEA. These concerns were sufficiently far reaching that Congress was required to enact a moratorium on most CFTC actions with respect to swaps transactions in order to preserve legal certainty and market stability. That legislation was an important action that served to calm concerns of the markets during this time. It is important to note that this was a temporary measure (which has now expired) and it did not attempt to resolve issues related to the underlying causes of legal uncertainty. The legislation also directed the President's Working Group on Financial Markets to conduct a study of the treatment of swaps transactions under the CEA. The Report reflects the results of that study.

In addition to its concerns that legal uncertainty poses systemic risk, the Working Group concluded that "[a] cloud of legal uncertainty has hung over [swaps transactions] . . . in the United States in recent years, which, if not addressed, could discourage innovation and growth of these important markets and damage U.S. leadership in these arenas . . ."

Legal uncertainty creates barriers to innovation. For instance, as the Report notes, "uncertainty involving OTC derivatives has hampered private sector efforts to utilize electronic trading systems that would enhance market efficiency and transparency." Financial institutions in the United States must have the opportunity to respond to market changes and customer demands without having to overcome unnecessary regulatory obstacles that do not exist elsewhere in the world.

The Working Group also concluded that there was no compelling policy justification for regulating swaps transactions under the CEA. This conclusion is consistent with the view taken by the CFTC itself in its 1989 Swaps Policy Statement (which remains in effect) that swaps transactions generally are not appropriately regulated as "futures" under the CEA. This view in turn formed the policy foundation for Congress' action in 1992 directing the CFTC to use its then new exemptive authority to exempt most swaps transactions from almost all provisions of the CEA. In light of its conclusion that swaps transactions generally need not be regulated under the CEA, the Working Group recommended that Congress provide "legal certainty" by amending the CEA to provide a new statutory exclusion for swaps transactions, including swaps involving non-exempt securities, between sophisticated counterparties.

ISDA agrees with the Report's conclusion that there is no compelling policy justification for regulation of swaps transactions under the CEA. Participants in swaps transactions are sophisticated entities that do not require the special consumer protections available to retail investors in exchange-traded futures contracts. Moreover, swaps transactions do not serve the price discovery functions, or present the potential for manipulation, that serve as the policy rationales for CEA regulation. For these reasons, ISDA urges Congress to enact legislation this year to provide legal certainty for swaps transactions. The legal certainty provision in the Risk Reduction Bill would, if enacted, accomplish this goal.

The Regulatory Status of Swaps Involving Energy and Other Commodities

The Working Group concluded that the proposed new statutory exclusion for swaps transactions should not encompass swaps involving non-financial commodities in finite supply. The Report notes that there are special factors that make agricultural markets susceptible to pricing distortions and manipulation; that there have been efforts in the past to manipulate the prices of certain metals and that the cash markets for many non-financial commodities depend upon the futures markets for price discovery.

While the majority of swaps transactions today involve financial "commodities", swaps transactions involving many physical commodities, such as certain energy products, are becoming increasingly important hedging tools. Congress needs to provide comparable treatment for other types of swaps transactions where a compelling policy rationale for regulation (under the CEA or otherwise) cannot be demonstrated. If distinctions of the type contemplated by the Report are to be drawn among categories of swaps transactions, Congress should consider whether the line of demarcation proposed by the Working Group (i.e., "non-financial commodities in finite supply") would have an undesirable chilling effect on new and emerging products. ISDA believes new and emerging risk management products should be encouraged and this requires that they receive comparable legal certainty treatment where a compelling policy rationale for regulation cannot be demonstrated.

As noted above, under the Risk Reduction Bill the CEA would continue to apply and the CFTC would retain jurisdiction under the multilateral clearing provisions and the electronic trading provisions of transactions involving nonfinancial commodities with finite supplies. Although this approach is consistent with the Report, ISDA believes that swaps involving energy, certain metals and other physical commodities having highly liquid cash markets should be given the same legal certainty and the same regulatory treatment as swaps involving financial commodities. For example, the market for various energy products is very deep and liquid and is thus unlikely to be susceptible to price distortion and manipulation. The Report did not cite any specific evidence that the commodity swaps market has been subject to manipulation. The underlying cash markets remain the source of the price discovery the CEA seeks to protect. Increased liquidity to these markets is in large part due to deregulation of the energy markets, which has allowed the market to grow and innovate. Unless comparably treated, innovative risk management transactions in areas such as energy may be stifled to the detriment of U.S. businesses and other U.S. end-users.

Electronic Trading

ISDA agrees with the recommendation of the Report that the CEA be amended to ensure that execution of excluded swaps transactions through electronic trading systems does not provide a basis for regulation of either the transactions or the system. For the reasons set forth in the preceding section of this statement, ISDA believes that the Report’s recommendations with respect to electronic trading should be extended by Congress to encompass swaps transactions involving physical commodities having highly liquid cash markets.

Congress and regulators should focus on the underlying activities that are conducted on electronic trading systems and not on whether one kind of technology or another is employed to carry on those activities. For example, a swaps transaction between two dealers or between a dealer and one of its institutional customers that is not now regulated (under the CEA or otherwise) when effected by telephone should not be subject to regulation when it is conducted through the use of a more "contemporary" electronic system.

Historically, swaps transactions have been negotiated through telephone conversations. Dealers dealt over the telephones directly with other dealers or indirectly through brokers. The fact that computers are replacing telephone conversations should not lead one to conclude that unregulated transactions need to be regulated. Systems that limit participation to a single dealer and its customers do not present the same public policy issues that exist for trading on organized futures exchanges. A single-dealer system where only one market maker is transacting with its customers does not pose the same risks as an exchange in which the entire market is participating.

Additionally, some multiple-dealer systems automate the services traditionally performed by an interdealer voice broker. Using a screen-based system to carry out the same basic activity does not fundamentally change the public policy implications of an interdealer voice brokerage, whether voice or electronic. Issues of price manipulation, systemic failure and retail customer abuse are highly unlikely in systems limited to principal-to-principal transactions by substantial counterparties.

Electronic trading is becoming an integral component of the U.S. financial markets. ISDA believes this is a positive development and shares the views expressed in the Report that "the introduction of electronic trading systems for . . . [swaps transactions] has the potential to promote efficiency and transparency, and by enhancing liquidity and enabling firms to impose more reliable controls on their traders, to reduce, risks." Technological advances have and will continue to increase the liquidity, transparency and efficiency of the financial markets. In addition, the use of electronic trading systems will promote the integrity of financial markets by providing a "real time" audit trail. Electronically enhanced execution, and the immediate and accurate electronic capture of trade data, facilitates trading and operational efficiencies connected with the execution and clearance of transactions.

Electronic trading also facilitates the development of "real time" risk management systems. This is consistent with the policy of U.S. regulators to encourage increased focus on market risk and the use of sophisticated risk management measures. Moreover, increasing the efficiency of risk management and decreasing its costs will benefit the economy in general and not simply market participants.

For these reasons, Congress must ensure that the U.S. regulatory framework does not discourage developments in this area. The United States must continue to be competitive in the global derivatives business. If the regulatory framework is unable to accommodate and facilitate this development of electronic systems this business will most assuredly be conducted abroad. Unfortunately, as the Report itself acknowledges, this is not now the case because some have contended that the use of an electronic system to enter orders to execute transactions under some circumstances may disqualify the transactions from the Swaps Exemption issued by the CFTC even though the same transactions executed via telephone communications would be exempt. Historically, swaps transactions have been negotiated through telephone conversations. Dealers dealt over the telephones directly with other dealers or indirectly through brokers. The fact that computers are replacing telephone conversations should not lead one to conclude that unregulated transactions need to be regulated. ISDA thus believes that the Risk Reduction Bill is completely accurate when it finds that: "Interpretations of Federal law suggesting that the use of certain electronic technologies in the trading of over-the-counter derivative instruments might raise questions about their lawfulness have hampered the development of more efficient trading systems and, therefore, more effective risk management for financial institutions."

Exclusion from regulation (under the CEA or otherwise) of electronic systems for swaps transactions that are limited to sophisticated counterparties trading for their own accounts as recommended in the Report will encourage development of electronic trading systems and remove uncertainty about the applicability of the current swaps exemption to the development of electronic trading systems.

The electronic trading provisions of the Risk Reduction Bill represent an important first step in implementing the recommendations of the Report. There are, however, two issues that need to be addressed. First, as discussed above, these provisions should not be limited to swaps involving financial instruments, rates and indices. Second, these provisions cover only financial electronic trading systems where each participant is a "financial institution" This term would encompass all swaps dealers, but it would exclude sophisticated end users of swaps. ISDA believes that there is no reason to exclude sophisticated end users from realizing the full benefits of electronic trading.

Clearing Systems

The Report correctly recognizes that clearing may reduce counterparty risks otherwise associated with swaps transactions and in turn can reduce systemic risk by generally reducing the possibility of loss due to default. As the Report also recognizes, however, current law tends to discourage the use of clearing systems since they may jeopardize the application of the current administrative exemption for certain swaps transactions that are cleared. ISDA supports the recommendations of the Report that the CEA be amended to ensure that the use of clearing systems for swap transactions will not adversely affect the status of swap transactions under the CEA. ISDA also believes it is necessary to explicitly clarify that contracts that are cleared should not be regulated under the CEA simply because they are cleared.

ISDA also recognizes that the ability of clearing to reduce risk depends upon prudent operation. As the Report points out, ISDA understands that clearing may concentrate risk and that the risk management systems used by clearinghouses may therefore have prudentialregulatory implications. It is important to note, however, that Federal bank supervisors have managed to supervise banks’ involvement in major payment systems with very limited regulation. Clearing and settlement systems can be supervised with the establishment of an elaborate regulatory structure where every change in the system’s rules require public comment and approval by a federal regulator. ISDA believes that Congress should ensure that duplicative regulation or supervision does not occur among U.S. regulators and that U.S. regulators should be permitted to rely on the oversight performed by any other G-7 regulator.

It is not yet clear to ISDA as to the extent to which clearing will be developed and utilized for swaps transactions. ISDA nevertheless agrees with the premise of both the Report and the Risk Reduction Bill that there is no reason to have a legal and regulatory structure that impedes the development of clearing.

The Treasury Amendment

Under the Treasury Amendment to the CEA, swaps transactions in or involving foreign currency, government securities or certain other enumerated "underlyings" are excluded from the CEA unless "such transactions involve the sale thereof for future delivery conducted on a board of trade". ISDA believes that the Treasury Amendment has worked well for more than 25 years and provides a more stable framework for legal certainty than does the current administrative exemption for certain swaps transactions. Indeed, the global and huge foreign exchange market operates well without regulation. In ISDA's view, the Treasury Amendment should be retained as an integral part of a modernized CEA.

Nevertheless, a tremendous amount of litigation has arisen with respect to the Treasury Amendment. Many of these issues have now been resolved and the principal remaining issue concerns the scope of the term "board of trade". ISDA agrees with the recommendation of the Report that the Treasury Amendment be modified by Congress to substitute "organized exchange" for "board of trade". This clarification is an essential part of the legal certainty agenda. It would ensure that the Treasury Amendment would be administered in accordance with its original purpose to exclude from the CEA all transactions in the enumerated products that are not conducted on an organized futures exchange--whether or not the transactions are conducted on electronic trading facilities or are subject to clearing and settlement arrangements. As noted earlier, ISDA believes that the development of electronic trading systems and clearing facilities which provide the additional benefits of enhanced portfolio diversification, credit risk management and market access should be encouraged with respect to swaps transactions generally and this is no less true in the case of swaps transactions covered by the Treasury Amendment.

Hybrid Instruments

ISDA agrees with the Report’s recommendation to provide legal certainty for hybrid instruments that reference non-exempt securities by clarifying that the Shad-Johnson accord shall not be construed to apply to hybrid instruments that have been exempted from the CEA.

Hybrid instruments are securities or deposits (already regulated by the SEC or banking regulators) that possess features similar to commodity futures and commodity options and facilitate risk management and investment opportunity. OTC contracts based on or involving non-exempt securities allow parties to transfer the risk associated with changes in the price of an underlying security, basket of securities or securities index without transferring ownership of the securities themselves. These transactions permit institutional investors and portfolio managers the flexibility to hedge risks associated with securities markets and to invest in new and emerging financial markets. They also allow firms to diversify their exposures to credit risk thereby providing an important systemic risk management function.

It is important that there be no questions about the legal enforceability of these transactions in the U.S. Many market participants, including U.S. firms, have sought to enter these types of transactions in jurisdictions outside the United States because the legal framework for these transactions are more favorable.

Regulation of Swaps Dealers

ISDA agrees with the Report’s recommendation that no legislative action be taken to regulate those swaps dealers that are otherwise unregulated. In reaching this conclusion, the Report notes that swaps transactions involving dealers that are not affiliates of banks, broker-dealers or FCMs account for only a small percentage of swaps transactions and cites "the apparent effectiveness of counterparty discipline in containing the risk-taking of such . . . dealers". ISDA welcomes the decision of the Working Group not to seek regulation of swaps dealers as such and believes it is important to underscore why this is the correct result from a policy point of view.

While many swaps dealers or their affiliates are regulated by, for example, banking regulators, it must be emphasized thay they are not regulated because of their swaps activities. Instead, in the case of banks, they are regulated because they hold taxpayer-insured funds and have a special role with respect to protecting public funds. In short, they are regulated by reason of their institutional nature and all of their transactions--not just their derivatives transactions--are subject to supervision. In some instances, as in the case of insurance companies, this regulation occurs at the State level, but the regulatory rationale is based on ensuring that these firms remain sufficiently solvent to meet their obligations to policyholders. No compelling policy case has been put forth for governmental regulation of derivatives dealers solely because of their participation in swaps transactions. Similarly, no compelling policy case has been put forth for direct governmental regulation of swaps transactions. As noted earlier, swaps transactions are entered into by sophisticated counterparties acting as principals. Each is capable of assessing the credit risk of their counterparty or will otherwise rely on credit rating agencies or professional advisors. Dealers with lower credit ratings will find their proposed swaps transactions rejected by other financial market participants or they will be entered into only if significant credit enhancements are provided. This self-policing in the swaps industry has worked well to date. While some dealers have failed, those failures did not come near to having systemic consequences. Those who seek to extend regulation into this area of the market should bear the burden of demonstrating the need for regulation and that the benefits of implementing such regulation exceed the cost.

Netting

ISDA, as an early leader in the advancement of netting contracts, agrees with the Report’s recommendation to enact into law improvements in the netting regime for derivatives.

The April 1999 report, Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management states, "the ability to terminate financial contracts upon a counterparty’s insolvency enhances market stability. Such close-out netting limits losses to solvent counterparties and reduces systemic risk. It permits the solvent parties to replace terminated contracts without incurring additional market risk and thereby preserves liquidity. The ability to exercise close-out netting also will generally serve to prevent the failure of one entity from causing an even more serious market disruption."

ISDA has long advocated improvements to the United States Bankruptcy Code, the Federal Deposit Insurance Act (FDIA), and the Federal Deposit Insurance Corporation Improvement Act (FDICIA). Provisions to allow cross-product netting and expansion and clarification of financial contracts eligible for netting minimize the risk of a disruption of financial markets upon the insolvency of a participant in those markets. ISDA believes these provisions, which were passed by the Senate in February 2000, should be enacted into law as expeditiously as possible.

ISDA notes that other jurisdictions, including the European Union, have enacted legislation to make clear that the netting of financial obligations is effective under their current bankruptcy regimes. Other countries with major financial centers are enacting legislation that ensures that their financial markets rest on solid legal foundations. Financial market participants will conduct business in those centers that provide that foundation. Market participants will insist on legal opinions confirming the strength of these foundations. They will seek to avoid markets and participants in markets with weak netting and banking regimes. Enactment of these enhancements to the Bankruptcy Code, the FDIA and the FDICIA will help to better ensure the vitality of the United States financial markets.

ISDA and the Bond Market Association have actively advocating improved netting legislation in the United States since 1996. This important legislation has come close to final enactment in the past. ISDA believes that there is no controversy concerning the netting legislation. Rather, delay has been caused by the fact that the netting legislation has been included as part of a more comprehensive, and controversial, bankruptcy reform proposal. If the more comprehensive bankruptcy legislation cannot be enacted this year, ISDA urges that the netting provisions embodied in H.R. 1161 (introduced by Chairman Leach and co-sponsored by Representatives LaFalce and Roukema) should be enacted separately without further delay.

Conclusion

The recommendations of the Report that are unanimously supported by the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve System, the Chairman of the Securities and Exchange Commission and the Chairman of the Commodity Futures Trading Commission should serve as a catalyst for Congressional action this year..

ISDA wishes to emphasize specifically that implementation of the Report’s recommendations will achieve the important goal of reducing systemic risk. Legal certainty for swaps transactions will permit businesses, financial institutions, government entities and other end users to manage their financial and commodity market risks with a degree of efficiency and effectiveness that would not otherwise be possible. The development of electronic trading serves to reduce systemic risk by increasing liquidity, efficiency and transparency of the financial markets. The ability of clearing systems to develop without regulatory impediments may reduce systemic risk by allowing financial institution to reduce the possibility of widespread loss due to default. Finally, an improved netting regime for derivatives to allow orderly termination of financial contacts upon a counterparty’s insolvency preserves market liquidity and market stability thereby preventing serious market disruption.

ISDA applauds the introduction of the Risk Reduction Bill. We look forward to working with the Committee on Banking and Financial Services and other relevant Committees to secure legislation that is consistent with the recommendations in the Report and will provide legal certainty for all swaps transactions.

 

 



 

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