Committee on Banking
and Financial Services
James A. Leach, Chairman
|For Immediate Release:|
|Tuesday, April 11, 2000|
Of Rep. James A. Leach
Chairman, House Banking and Financial Services Committee
Hearing on Over-the-Counter Derivatives, Hedge Funds and Netting Proposals
Todays hearing will address three areas - over-the-counter derivatives, hedge funds, and contract netting - where legislative proposals are pending to reduce systemic risk to the financial markets. The legislation, in each case, is based upon recommendations from the Presidents Working Group on Financial Markets. The Working Group, which consists of the Secretary of the Treasury and Chairmen of the Federal Reserve, the Security and Exchange Commission and the Commodities Future Trading Commission, has creatively examined system-wide issues across the legalistic and jurisdictional divides that normally separate one regulators thinking from anothers.
The Working Groups newly established and long overdue consensus on OTC derivatives is momentous for the banking industry, banking regulators, and this Committee. An overwhelming majority of financial OTC derivatives transactions involve one or more banks. Not only do the largest commercial banks conduct most of the dealer activities for financial swaps and related derivatives, but banks and other financial institutions of all kinds and sizes are the largest-scale end users of these contracts.
OTC derivatives - particularly interest-rate, foreign exchange, and credit derivatives - have become essential to banks risk management strategies, proprietary trading activities, international operations, and services to institutional customers. For these reasons, this Committee has had a vigorous and sustained interest in derivatives issues for well over a decade.
In 1993, the then Committee Minority issued what remains the most comprehensive analysis of over-the-counter derivatives ever produced in Congress. Many of the issues addressed in the Working Groups 1999 report were raised in that report.
In the six and a half years since, these markets have increased dramatically. According to recent OCC figures, the notional measure of U.S. commercial banks derivatives transactions is almost $35 trillion, and of this amount $31 trillion represents OTC derivatives activities, yielding some $2.5 billion in revenues. The most recent total of banks credit exposure from off-balance sheet derivatives contracts is $396 billion. In sum, banks are central to financial OTC derivatives markets and these markets have become central to a wide range of banking activities.
The Working Group rightfully recognized that the legal uncertainties surrounding these products could unnecessarily pose serious risks to the financial system, including insured institutions. These uncertainties have impeded the development of multilateral clearing and electronic trading mechanisms and raised the specter that contracts might be renounced, particularly during a time of economic disruption.
Moreover, the competitive position of the U.S. banking system and the effectiveness of U.S. governments oversight over financial markets will be weakened if the confused state of U.S. law and regulation causes the trading and clearing of OTC derivatives to become concentrated overseas. For these reasons, H.R. 4203, the Over-the-Counter Derivatives Systemic Risk Reduction Act, seeks to begin to solve these problems in a manner generally consistent with the substance and tone of the Working Groups OTC derivatives recommendations.
These legislative recommendations would not be any regulators or legislators first choice on how to provide a regulatory framework for OTC derivatives. Instead, they represent a compromise among the different Federal regulators who regulate different financial institutions for different purposes.
Although in general terms I support the derivatives reforms recommended by the Working Group last November, H.R. 4203 does not set out to accomplish them all. (Nor, for that matter, does the Working Group Report address all that needs to be done to make U.S. financial derivatives trading as safe and competitive as it can and should be.) Rather, H.R. 4203 prioritizes those Working Group recommendations that are central to the reduction of systemic risk and the promotion of safe, efficient, and innovative business practices in the financial sector.
H.R. 4203 would work best if combined with or moved forward alongside other legislation aimed at other Working Group recommendations. Among other things, laws need to be passed excluding swaps and related OTC derivatives from the Commodities Exchange Act (CEA), updating the so-called Treasury Amendment, reforming the Shad-Johnson provisions, and giving the SEC and the CFTC authority to regulate clearing of OTC derivatives that are not futures, commodity options, or securities.
The exigencies underlying H.R. 4203 dictate, however, that this Committee needs to proceed even if legislative efforts on the other Working Group issues are slowed by complicated jurisdictional and definitional questions.
Even if it were passed separately from a complete package, H.R. 4203 would further important policy goals. It would put an end to the unfortunate legal ambiguities that could threaten to abet attempts to rescind contracts, prevent the development of multilateral clearing, and impede the use of cutting-edge information and communication technologies in the negotiation of the transactions.
Let me also note that H.R. 4203 is, not surprisingly, a work in progress and we are continuing to work with government and private groups to improve it.
In the hedge fund area, Subcommittee Chairman Bakers legislation, H.R. 2924, the Hedge Fund Disclosure Act, of which I am a cosponsor, rests on the proposition that marketplace surveillance and transparency are the preferred means of mitigating the risk posed by hedge fund activities. The gentleman from Louisiana, who will be our first witness today, is an advocate for reducing risk to the financial system, and we agree that there is no responsibility of this Committee more important than safeguarding against systemic risk.
Finally, in the financial contract netting area, which is also of particular concern to financial regulators and the derivatives community, there is broad support for H.R. 1161, the Financial Contract Netting Improvement Act. It is the Committees intention to move this legislation forward if the procedural concerns surrounding the bankruptcy bill make it necessary to do so.
HR 1161 amends the U.S. Bankruptcy Code and a number of Federal banking laws to address the treatment of certain financial transactions following the insolvency of a party to such transactions. The amendments clarify and improve consistency between the applicable statutes and minimize risk of a disruption within or between financial markets upon the insolvency of a market participant. The near failure of Long-Term Capital Management LP highlights the need for the U.S. to further refine its bankruptcy and insolvency laws in order to avoid systemic risk to the nations financial system in the event of a failure of a large bank, hedge fund, or securities firm with huge exposures to interest rate and currency swaps and other complex financial instruments.
In summary, the nations regulators have given Congress fair warning that we need to update our laws in these three areas. Like the regulators we need to put aside jurisdictional concerns and move forward to enact these legislative recommendations for the nations economic well being.