Regulating the Derivatives Market
Financial Regulatory Morass: Delay in Dodd-Frank and Excluding Derivatives
The Treasury Department has proposed excluding certain foreign-exchange instruments from new rules on derivatives trading that were included in the Dodd-Frank Wall Street Reform and Consumer Protection Act that was signed into law by President Obama on July 21, 2010. Not surprisingly, business groups support the proposal. Tim Ryan, president and chief executive of the Securities Industry and Financial Markets Association, is quoted in the Wall Street Journal as saying, the Treasury's proposal to exempt these products "goes far in ensuring these markets will remain vital tools for business." The claim is foreign exchange derivatives are necessary for businesses and hedge fund managers to protect against currency fluctuations. Let's assume this is true, but why should they escape regulation? Traders can manipulate foreign exchange markets just as they have done with oil prices and other commodities.
It's hard to believe the Treasury is going to fall for the same line as when businesses fought tooth and nail to end the Glass-Steagall Act of 1933 that built a wall between commercial and investment banking services. The result of lobbying efforts was the passage of the Gramm-Leach Bliley Act, also known as the Financial Services Modernization Act of 1999 that repealed Glass-Steagall. It opened up the market for mergers between banking, securities and insurance companies giving us the mega-conglomerate Citigroup. The rationalization of economies of scale turned into a blank check from Congress to engage in unregulated action that caused the destruction of so much financial wealth and created economic misery for so many.
Perhaps a history lesson is in order. The Dodd-Frank Financial Reform Act calls for the adoption of the appropriate mechanisms to regulate derivatives. It's up to the SEC and CFTC to determine the scope and enforcement mechanisms to implement the law. The SEC has proposed some implementation measures but none have been adopted as yet. We are in the public reaction phase of the process and Congress is concerned about the slow path of adoptive regulations. Moreover, it is necessary to harmonize potential CFTC and SEC regulations implementing the derivatives provisions of Dodd-Frank with foreign regulatory counterparts to reduce systemic risk in our increasingly interconnected global marketplace.
CFTC Commissioner Jill Sommers has recently expressed her fears that differences with European Union draft legislation regulating derivatives are growing. The Commissioner is concerned that the CFTC is out of step with regard to timing and substance with both the SEC and non-US regulators. The CFTC is aware of the importance of establishing an appropriate regulatory framework for the cross-border swaps activities of foreign banks.
We need to adopt regulations for derivatives in the U.S. sooner rather than later and coordinate with global markets. Back in 2008, the Bank of International Settlements reported that the derivatives market is $683.7 trillion dollars. Let's put this into perspective. The gross national product (GNP) of the United States for 2008 as reported by the World Bank was 14.3 trillion dollars. The GNP of the world was reported by the World Bank at 69.3 trillion dollars meaning the global derivatives market is about 10 times the world GNP. What's wrong with this picture?
Are we to assume the derivatives traders have learned their lesson from the financial meltdown of 2008 and now, all of a sudden, will self-regulate and operate in an ethical manner? History proves otherwise. I fear we will be headed for another financial collapse within the next few years if the derivatives market remains unregulated and uncoordinated on a global basis. The fact is even with a regulatory regime in place there still will be unethical behavior by all too many because of the greed is good and pursuit of self-interests mentality that has infected business on a global scale.
Blog by Steven Mintz, aka Ethics Sage, May 3, 2011
Cartoon reproduced with permission