Reed Offers Bill to Establish A Comprehensive Regulatory Framework for Derivative Products
Legislation Would Create Strong Rules and Require Transparency
WASHINGTON, DC - In an effort to regulate all derivative products and address another key component of financial regulatory reform, U.S. Senator Jack Reed (D-RI), Chairman of the Banking Subcommittee on Securities, Insurance, and Investment, today introduced the Comprehensive Derivatives Regulation Act of 2009 (CDRA). Reed's legislation would for the first time establish a comprehensive regulatory framework to prevent derivatives trading activities from ever again contributing to catastrophic failures in our financial system.
"Last September, our nation found itself on the verge of a total financial meltdown—with decades-old financial institutions collapsing overnight and credit markets freezing up—in large part because companies like AIG took risky bets selling unregulated credit default swaps. Bets that backfired when the housing bubble burst. To ensure that we never again face another financial crisis of this magnitude, my Senate colleagues and I have been developing a series of critical reforms to the financial sector," said Reed. "As the Chairman of the Banking Subcommittee on Securities, Insurance, and Investment, I recently introduced bills to strengthen oversight of credit rating agencies and hedge funds, which until now have been subject to relatively little regulation. This legislation is another key step in filling the huge regulatory gaps in our financial system. It would put in place a truly comprehensive framework for regulating all such products."
Derivatives are financial contracts that investors use to hedge their risks or grow their portfolios. They are called derivatives because they derive their value from goods and services such as the price of corn or the price of a stock at a future date. While most derivatives offer companies the ability to better manage their risks, some irresponsible financial firms took major risks in recent years using new, untested, and unregulated derivatives products. When these firms faltered, it sent shockwaves through the U.S. financial system causing families to lose their homes, unemployment numbers to skyrocket, and the economy to go into recession.
"This bill requires transparency and clear rules, which are the fundamental building blocks of any healthy marketplace. While some may claim the financial system works fine as it is, the current state of the economy is an obvious mandate for change. The status quo is unacceptable for the economy and consumers, who continue to bear the cost of the crisis," said Reed.
Reed's CDRA Act of 2009 will:
• Require standardized credit default swaps and other unregulated derivatives to be cleared through a clearinghouse. This would protect the companies and the financial system from the risks posed by these instruments. Importantly, the bill also grants regulators the ability to oversee any new derivative product in the future, so dealers can no longer create products that fall into holes in the law.
• Establish robust capital and margin requirements for derivatives dealers and other major market participants, and subjects them to higher standards for products that are not traded on clearinghouses.
• Subject firms to new conduct requirements to protect investors from abusive practices in the market. It also includes new recordkeeping and reporting requirements to ensure that regulators and investors have broad information about derivatives transactions and positions throughout the financial sector.
• Combat fraud and manipulation in derivatives markets by giving regulators new authority to set position limits and oversee the marketing of products to certain investors. The bill strengthens thresholds in place to ensure only sophisticated investors are engaging in certain types of trading.
• Rationalize the sharing of jurisdiction between the SEC and CFTC, and establish a process for quickly assigning responsibility for new products so they do not fall through the cracks. Specifically, the bill provides the SEC with jurisdiction over all derivatives that are securities or can be used as synthetic substitutes for securities, because without such authority over products that can affect securities markets, the SEC cannot accomplish its mission to protect investors and ensure the integrity and fairness of markets. It gives the CFTC jurisdiction over all other derivatives, and creates a fast and efficient process for the United States Court of Appeals for the District of Columbia Circuit to resolve any differences in views between the agencies that might arise.
"As part of broader financial regulatory reform, I have recently chaired Banking subcommittee hearings to help identify the causes of the current financial crisis; examine how these causes magnified risk and weakened our regulatory framework; and determine policy changes needed to stabilize the U.S. economy and prevent future crises. If we seize this moment to fundamentally overhaul the financial system, we can begin to emerge from this recession with a stronger and more robust economy," concluded Reed, who will soon hold a hearing on reforming the securitization process.
Other recent hearings held by Reed have focused on corporate governance, hedge funds, over-the-counter derivatives, the SEC's enforcement activities, and risk management at large financial institutions.
In May, Reed introduced legislation to reform the credit rating industry and improve the accountability and accuracy of credit ratings. His Rating Accountability and Transparency Enhancement (RATE) Act of 2009 would give the Securities and Exchange Commission (SEC) strong new authority to oversee credit rating firms and hold them accountable for conflicts of interest and other internal control deficiencies that have weakened ratings in the past.
Building on the notion that transparency and disclosure are essential in today's marketplace, Reed subsequently introduced legislation in June that would strengthen financial oversight of hedge funds and other private investment funds. Reed's Private Fund Transparency Act of 2009 would will help protect investors, identify and mitigate systemic risk, and prevent fraud. This legislation amends the Investment Advisers Act of 1940 to require advisers to hedge funds, private equity funds, venture capital funds, and other private investment pools to register with the Securities and Exchange Commission (SEC).