Treasury Backs Down Again on Derivative Regulation

The Over-the-Counter Derivatives Markets Act of 2009, the Administration's newest legislative language on the subject, was sent to the Hill this week.  While the purpose of the bill is to improve “regulation and transparency for all Over-the-Counter (OTC) derivative transactions,” much of it is dedicated to divvying up authority between the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).  POGO doubts much good can come of such a division of power.

Although separation of power can be a good thing, POGO agrees with Professor Joel Seligman and others who argue that the division between the SEC and CFTC has resulted in too much regulatory arbitrage.  In fact, the SEC and the CFTC have a long history of regulatory turf battles.  Earlier this year, the Department of Treasury stopped short of trying to combine the two agencies to resolve the conflict in its financial regulatory “blueprint.” Instead it recommended that the agencies be required to “harmonize” their regulatory regimes.  By perpetuating this divide Treasury greatly increases the risk that OTC derivatives and Credit Default Swaps will come back to bite us in our economic butts.

Matthew Goldstein, a commentator for Reuters, pointed out that the legislation also leaves it up to the warring Commissions to come up with the formal definition of a “derivative” subject to a few loose guidelines.  He worries “this will permit too many derivatives to be classified as non-standard contracts–something that would exempt them from being traded on an exchange.”  If it is not on an exchange then the oversight of the product will be severely limited.  Treasury should put in a formal definition of a standard derivative before allowing the regulators to try and do it.  Leaving it up to the SEC and the CFTC would give industry the opportunity to influence the definition through back channels.

Congress needs to step back and think about what is at stake.  Part of the reason the original blueprint backed off of consolidation of the agencies was that it was viewed as politically untenable: Members of Congress would likely put up a fight in an effort to hold on to their committee jurisdiction.  They need to put aside their differences and their political aspirations.  The American people deserve to be protected and patchwork regulation is not the way to do it.

-- Eric Orenstein