House Ag hearing Sept 22
Chair Peterson: Standardized swaps and clearing?
Gensler: If a clearinghouse accepts a swap then it is standardized... nonstandard swaps should be allowed... rulemaking can be done by the clearinghouses (real clearinghouse) such is in your in Bill 777.
Shapiro: It's important that the integrity of clearinhouses is not threatened by accepting certain swaps... another layer of concern is if certain swaps would threathen the clearing house.
Peterson: How to regulate swaps if not directly regulated.
Gensler: Then they would be regulated by the dealer and through anti fraud provisions...
Shapiro: Legislation does lay out the dealer regulation.
Peterson: Who will regulate margining?
Gensler: The prudential regulator would regulate dealers... either the bank regulator or SEC.
Shapiro: Dealer has responsibility to oversee their counterparty and the contracts that they enter into in with them.
Lucas: Non financial dealers didn't have problems or systemic risk ... are you concerned that this would create bank monopoly and more systemic risk?
Gensler: Significant gaps of institutions were not covered ... AIG was not covered... we must cover anyone who holds themselves out to be derivative dealer... consistently apply in a non-discriminatory way.
Shapiro: Cover all dealers regarldess if they take deposits... otherwise it will migrate from well regulated to less regulated.
Lucas: Capital requirements will drive business to the hands with the deepest pockets?
Gensler: I don't see it that way... banks have capital charges already ... non banks don't currently have cap requirements.
Lucas: Number and volume of non bank dealers... should capital requirements be limited to those that pose systmic risk? Doesn't more dealers reduce risk to economy?
Gensler: If a company holds themselves out to be a dealer then their CFO and risk managemenet might already commit capital to this use and to other uses... unregulated entities might have an advantage.
Shapiro: Not comfortable to limiting cap requirements to just systemic institutions.
Gensler: Tier 1 already has other provisions and have other capital requirements ... not necessary that they have the same cap requirements as non Tier 1 entities.
Peterson: My understanding is that people are already paying for this... counterparty will not protect without extracting some benefit.
Gensler: Dealers currently charge counter parties for extending credit in these swaps.
Peterson: That will continue as long as it covers the costs of the risk.
Gensler: That is what we recommend on margin end users can enter into deals with the dealer but the dealer has to post collateral at the clearinghouse.
Boswell/Iowa: Sept 6 New York Times story on Wall Street bundling life insurance settlements? Should we allow this?
Shapiro: I'm profoundly worried about this issue and asked the SEC to form a task force to examine it... it's a multi-trillion dollar business now... issues around the Privacy Act, tax implications, multiple sales practice issues... we are aggressively exploring the issues.
Boswell: How would you regulate?
Shapiro: We need to understand the issues... such as sales practices issues.
Boswell: Bittersweet side of this... policyholders needing to cash out... trilions of dollars... very huge... I appreciate what you said lets keep in touch.
King: AIG... too big to be allowed to fail... how do you view the consequences if we hadn't invested that money in AIG... what would it have looked like?
Gensler: I think you ask a difficult question... what we were facing was quite uncertain.. AIG had a book of business of $450 billion... with Euro banks and 1/3 covering MBS here... would have cascaded around the system... first time in a decade money market broke the buck... Lehman failed... that run would have accelarated in the next few days...
King: Would it have rearranged things and sent a signal?
Gensler: We shouldn't have to face those decisions again.
Shapiro: I was a private citizen last fall... given the number of counterparties that AIG had that would collapsed... it would have been more difficult the last year if AIG had not been bailed...
King: Any discussion of requiring reinsurance on traders? how do we ensure reinsurance companies don't become tbtf?
Gensler: That is why we require capital and margin and this is an interesting idea.
King: Have either of you considered not requiring federal regulator of the first order and instead allowing the markets to be regulated at the OTC level?
Gensler: We do rely on some regulation by the exchanges but we set the rules...
Scott: AIG question... we need to examine the Financial Products division of AIG.. there was no effective Federal regulation same for Lehman Brothers, Bear Stearns... why no federal regulation there?
Shapiro: For LB and BS there was ineffective federal regulation at the SEC called the CSE it was voluntary... lessons learned suggest that capital rules were not adequate to adresss liquidity stresses ... institutions couldn't continue... more supervisory focus on the assets that were held by the institutions ... more stress tests... more understanding of low probability of extreme events... clear authority of regulators to adapt to new events.
Scott: CFTC oversight of foreign boards of trade will need to register with the CFTC and must adopt position limits and give the CFTC authority to limit positions?
Gensler: We have some foreign futures exchanges and maybe swaps in the future... maybe you are referring to the London loophole... if terminals are placed here or access is linked... we now use no action letters... just revised one with ICE Europe... had to do it with much diplomacy.
Scott: Are you concerned they will retaliate against the US?
Gensler: We have a good relationship with the FSA's Adair Turner.
Fortenberry: What is the purpose of the commodities markets and what % are hedgers vs speculators?
Gensler: These markets are over 150 years old... hedgers lay off risk and speculators take on the risk... we just broke out more data about who the market participants are... generally less than half are hedgers.
Fort: Since when are they half? Can these markets actually add instability to the system? We are going over and over with the question of why oil markets are disconnected from the fundamentals and if they need more capital/transparency/collateral requirements...
Gensler: All these markets are risk management and price discovery spaces... bring regulation and transparency to the OTC area... that will go a far way... aggregate position limits across markets especially on markets with finite supply...
Fort: Will open transparency help keep the markets from running up? can you project backward
Gensler: Given more totals we can police for corners and squeezes... we are not a price setting agency.
Marshall: Give CFTC sufficient discrition to set position limits... would it be helpful for the CFTC to get together with those proposing to clear and really examine the costs of clearing? Would we lose a lot of end users by forcing clearing?
Gensler: End users will benefit and take some of the cost out of the system by transparency.. central clearing will lower risk ... they will have to post margin ... require the clearing member to post margin and enter into individualized contracts...
Marshall: Can you put some numbers down? On page 7 central CCP must have open and fair access requirement and must accept trades to be cleared from all exchanges... clearinghouses would become familiar with certain products...
Gensler: We will try and promote competition between exchanges and CCP shouldn't be vertically integrated and exclude other exchanges... should be more like the options markets with one "utility" clearer (OCC) and many exchanges.
Shapiro... OCC for all exchanges and DTC for all stock exchanges..
Marshall: Not sure that those models will fit with this market...
Gensler: CCP would accept only products they understand.
Thompson: If treasury proposal becomes law how much will that cost?
Shapiro: Don't know how much that will cost... joint rulemaking will cost alot... approving clearing houses, overseeing the dealers is an examination program, reporting capabilities through a respositiy for transactions data... must understand that data... there is a lot to do here... on products that are valued at trillions and trillions.
Gensler: This committee included authorization of a 100 new staff for the CFTC... we now have 570 people.. we need to be much larger.
Thompson: Power producers say it would be harder to protect against swings... in your view how will this legislation affect overall markets?
Gensler: Greater transparency will benefit these markets... OTC markets are opaqaue and many want to keep it opaque... some costs for posting margin. I proposed a solution where clearing members post the margin.
Thompson: Will this dry up liquidity?
Gensler: No it will take certain advantages from certain big dealers...
Kagen: Glad to hear that you are against making the Federal Reserve the systemic risk regulator...
Shapiro: My perspective is that we need a systemic regulator and could be the Federal Reserve but we need a council of regulator to take on role of oversight of macro prudential risks and set capital requirements that could be higher than the main regulator set...
Thompson: If we elimante those institutions that are TBTF we wouldn't need a systemic risk regulator? Should we break up up TBTF into regional entities?
shaprio: We can't suffer under the TBTF any more.
Thompson: O'Connor's testimony last week that we are in a more dangerous situation from such a concentration?
Shaprio: We are still at risk and must regulate.
Gensler: Concentration... I do think these markets have become too concentrated and unreasonably concentrated our markets are better served by a minimum number of participants... they internalize the deal flow and don't expose to public view.
Thompson: Will this push trading offshore?
Gensler: Important to work internationally.. everyone reaching out internationally... Congress and regulators... must protect the American public... reach out to colleagues in Europe and Asia.
Thompson: One reason for lack of confidence is that we haven't caught the crooks and still have systemic risk... please respond in writing about catching the crooks.
Schrader: Are we destined to repeat errors of the past...such as not regulating swaps...repealing Glass Steagall... I'm scared by more liquidity... spreading liquidity... TBTF I associate myself with the comments of Thompson... how do we measure the outcome of this effort?
Gensler: Participants must be able see the what they are trading and we must see the large financial institutions are setting aside capital for these transactions that they are entering into...
Shapiro: Hedgers have legitimate reasons to be in these markets... free markets.. risk must be well managed by the dealers and the public has information about these markets...
Lummis: Non cash collateral? This is essential for legitimate hedging...
Gensler: I've meet with lots of energy companies... can bring this info onto exchanges and can set up arrangements with dealers to accept other collateral than cash...
Lummis: You are harmonizing rulemaking... then add in the Fed Reserve as a regulator... how do they fit into this?
Shapiro: The Treasury will be the tiebreaker... I have some concern with that as independent agency... this is not an insignificant task.. enormous amount of effort... oppurtuntiy for industry or others to go up to the next level and intervene.. we might offer an alternative in Gramm Leach Bliley that would allow appeal to the Court of Appeals on rulemaking going forward...
Gensler: Clearing and exchanges we will regulate together... market functions should be overseen by SEC/CFTC.
Lummis: Duffy said CFTC should oversee commodities and SEC oversee secutiies and if both then exchange should pick regulator..
Gensler: We must do better at joint oversight... challenge in interest rate swaps or broad base indexed security where CFTC took the lead.. more joint rule making... two alternatives... do a lot of joint rule making or a way to say that this agency does these products...
Shapiro: "Primary component" of regulation... mixed products.
Dalehkemper: How do you define systemic risk?
Shapiro: Ability of an institution to bring down other institutions, or markets... activities or institution that have potential to harm others.
Gensler: Congress amended the Commodities and Exchange Act 8/9 years ago... added the mission to protect against systemic risk.. one of the mission of the CFTC is the avoidance of systemic risk...
Dalehkemper: Madoff could have been exposed decades earlier... what has been done?
Shapiro: Look at website of the steps we have taken... skills and training.
Pomoroy: How will clearing houses work with non standard products? Collecting information since 2008... are you making progress on the charactersics?
Gensler: Interest rate swaps to credit default swaps have different proportions that can brought to CCP.. CDS is 40% indices... markets will benefit... someone in North Dakota will benefit from seeing prices for similar products.
Pomoroy: Council of regulators... I can't believe the chinks were so large that this crisis happened... why would it work better now?
Shapiro: It works with a systemic risk regulator.. council is a counterbalance... if regulator has multiple responsibilities... council can bring a broad view of the markets... share information...
Murphy: Segregation of assets and solvency... Chair Gensler do you agree with Chair Shapiro?
Gensler: The system failed and I look forward to whatever the Congress decides. My goal is to oversee the OTC markets
Murphy: Bilateral trades -- segregation of assets?
Gensler: Customer accounts that post margin need to be segregated... modest changes need to be made bankruptcy law...
Murphy: Margin requirements for customers work out with derivative dealers what their credit needs to be... Treasury pushing for harder margin requirements...
Gensler: I've evolved over this... bring all standard products into clearing and allow users to have arrangements with members...
Murphy: Whatever the CCP takes is standard... is this a reasonable standard that is hard to implement?
Gensler: It's all prospective... transparency through rule making..
Shapiro: Burden on the dealers and on the CFTC and SEC on what is accepted for clearing.
Cassidy: Small users will need a clearing party to loan them the money to monetize their assets to hedge... they will pay higher costs for that...
Gensler: Current opaque system is now a hindrance to small users... opaque markets benefit big players... small parishes in your district would see what is happening in the markets.. small users already have costs embedded in these products... receiving an extension of credit...
Cassidy: Letter from constituent their collateral is their natural gas reserves.
Gensler: Dealers would be allowed to enter into a credit arrangement with the end user with the gas in the ground as collateral... if currently posting physical assets in the ground it remains the same... if posting no collateral it's already in the contract...
Peterson: gonna cost the big players money and save money for the same guys standardize clearing then you narrow the spreads... at the heart of the same thing...
Minnick: where a product originates shouldn't establish where it is regulated... and if you can't agree that this should go to the Treasury for resolution... and question Shapiro's suggestion that it go to a judicial authority... create MOU for who has primacy... using capital, collateral, margin? could you work that out so we could have a roadmap on which agency would work on issues..
Sharpiro: judicial approach in Gramm-leach-Bliley... joint rule making authority will be difficult and time consuming... since not merging agencies... where to draw the lines became more complicated... it is difficult
Gensler: good suggestion and Congress is the first plae to draw lines and have a more explicit MOU.
Peterson: Chairman Frank and I agreed to narrow this gap here... were are going to do everything we can...
Childers: lot of horsepower here this morning...
Peterson: exclude foreign traded swaps from Treasury... why regulate this class of swaps?
Gensler: we must cover all classes any exceptions are clearly targeted and can't be used to avoid oversight... exclude forwards but cover futures...
Shapiro: not an SEC issue but from CFTC days... retail FX trading must be overseen...
Peterson: Justice Department looking into whether unfair advantage for ownership
Gensler: CCP have open governance and not subject to ownership control issues...
Shapiro: CCP have broad ownership and better federal oversight of CCP
Marshall: get together with CCP and decide the costs of the different approaches
Gensler: hard to do an analytic on the specifics of different costs
Peterson: much of these arguments are coming from those who want to keep everything the same
Gensler: trying to push the risk back into the dealer community... some in the financial community who would prefer not to have this paradigm shift... we now mutualize the risk now and the Americans carry the risk... we will do our best to do that and that is the core of the debate right now...