SEC votes on plan to police swaps, derivatives

By Reuters
Posted Oct. 13, 2010 at 12:53 p.m.

The top U.S. securities regulator Wednesday took its first stab at policing the $615 trillion over-the-counter derivatives market with a plan to mitigate conflicts of interests at venues that will handle the swaps.

The Securities and Exchange Commission voted 5-0 to propose ownership limits on the swaps trading venues and clearinghouses, which will assume the risk if one party defaults.

The derivatives — financial instruments companies use to hedge risk such as interest rates — have been fingered for contributing to the worst financial crisis since the Great Depression.

“This proposed rule is intended to make these entities less susceptible to promoting the interests of a few participants to the potential detriment of others,” SEC Chairman Mary Schapiro said at a public agency meeting.

The SEC and fellow market regulator the Commodity Futures Trading Commission are crafting dozens of rules to regulate the opaque market under the Dodd-Frank financial reform bill.

The SEC proposed two plans to crack down on potential conflicts at clearinghouses whose members could try to limit which products could be cleared.

Under the SEC’s first plan, a clearinghouse member could only hold up to 20 percent of a clearinghouse. Members collectively could only be allowed to hold up to 40 percent of a clearinghouse, and a third of the clearinghouse’s board of directors must be independent.

Under the alternative plan, a clearinghouse member would only be allowed to own a 5 percent voting stake and the majority of the venue’s board would have to be independent directors.

The SEC’s proposal is similar to a plan the CFTC floated earlier in October, though the securities regulator is pushing for more independent board directors.

A handful of banks dominate over-the-counter derivatives dealing, including Goldman Sachs, JPMorgan Chase, Citigroup, Bank of America and Morgan Stanley.

“Those dealers earn significant revenues from their transactions in an opaque over-the-counter market,” Schapiro said.

The SEC proposal caps ownership in swap execution facilities, or trading venues for swaps, at 20 percent and requires a board composed of a majority of independent directors.

SEC commissioners also voted to require swaps done before the Dodd-Frank Act to be reported to the SEC or a swaps repository.

One type of derivative known as credit default swaps nearly toppled insurer AIG and forced the U.S. government to use billions of dollars in taxpayer funds to prop up the company.

Policymakers are hoping that forcing most of the swaps onto exchanges and requiring clearinghouses to clear the financial instruments will give regulators a view on the market and avoid a repeat of the 2008-09 financial crisis.


Under the legislation, the SEC must craft more than 100 new rules for financial players and the equity markets.

At the meeting, the SEC tried to shed more light on asset-backed securities after those packed with subprime mortgages plunged in value when the U.S. housing market collapsed.

The SEC voted 4-1 for a proposal requiring banks and other issuers of asset-backed securities to review the underlying assets and then publicly disclose the findings of the review.

Democratic SEC Commissioner Luis Aguilar dissented and said the SEC should impose a minimum review standard.

“It appears to me that this rule is essentially an endorsement of the ‘anything goes’ approach of the past,” Aguilar said at the meeting.

“I hope that the public and members of Congress will send the SEC comment letters urging it to adopt a real standard of review,” he said.

Fellow Democratic SEC Commissioner Elisse Walter and Schapiro indicated that they favored a minimum standard but said they wanted to input from the public.

The proposal is designed to ensure that investors, banks and their regulators know what kind of assets are underlying a complex security such as an asset-backed security linked to mortgages.

Banks were forced to record billions of dollars in mortgage-backed security losses during the crisis. The asset-backed security proposal is open until Nov. 15 for public comment. The swaps venue proposal is open for 30 days.

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