Clearing Derivatives at Issue

WASHINGTON — Congress should only require mandatory clearing of standardized interdealer over-the-counter derivatives transactions in which at least one of the dealers is systemically significant, the chief executive officer of the International Swaps and Derivatives Association told lawmakers yesterday.

Both the Treasury Department’s proposed legislation and a bill sponsored by the chairmen of the House Financial Services and Agriculture committees would mandate central clearing and exchange trading of standardized derivatives contracts.

But Robert Pickel, the ISDA’s CEO, told members of the House Agriculture Committee yesterday, “Not all standardized contracts can be cleared.”

Pickel said that derivatives contracts that are infrequently traded, even if they have standardized economic terms, “are difficult if not impossible to clear” because a central counterparty clearing facility’s ability to clear a contract depend on such factors as liquidity, trading volume and daily pricing.

This “makes it difficult for a clearinghouse to calculate collateral requirements consistent with prudent risk management,” Pickel said. “End-users are not systemically significant and ­regulations intended to improve stability and decrease systemic risk should not ­apply to them.”

Jonathan Short, senior vice president and general counsel of the ­IntercontinentalExchange Inc., also said Congress should focus regulation on the segments of the market where risk is greatest.

“Mandating that interdealer and major swap participant trades be cleared would eliminate the bilateral counterparty risk that was central to the liquidity crisis that occurred last year,” he said.

Pickel also argued against mandatory exchange trading of OTC derivatives, warning it “would undercut their very purpose: the ability to tailor custom risk-management solutions to meet the needs of end-users.”

Dan Budofsky, a partner at Davis Polk & Wardwell LLP, who testified on behalf of the Securities Industry and Financial Markets Association, agreed that “it may be more appropriate for products that trade less frequently to trade over-the-counter.”

Witnesses also challenged the Treasury’s plan to impose capital requirements on cleared swap transactions. This would require the end-user businesses to post collateral for the swaps, Budofsky said.

Collateral requirements for corporate end-users “would create a significant ­disincentive to use swaps to manage risk,” he said.

Gary Gensler, chairman of the Commodities Futures Trading Commission, has suggested that end-users could other assets as collateral instead of cash.

However, this would expose businesses “to unacceptable levels of risk,” Budofsky argued. Committee chairman Collin ­Peterson, D-Minn., stressed that he does not want to limit companies’ ability to engage in swaps.

“We’re not really here to put you in a tougher position,” he said. “But in the process I don’t want to leave a loophole that will get us back in this position. We are not going back to the system we had ­before.”

The House Financial Services Committee is expected to mark up derivatives legislation October, said a spokesman for Peterson. Both committees agreed in July to cooperate on derivatives regulation. The spokesman said the derivatives bill, which was already approved by the Agriculture Committee, might have to be “massaged” at some point to mesh with the Financial Services Committee legislation.

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