Beefing Up SEC's OTC Oversight

WASHINGTON - Congress must strengthen the Treasury Department's proposed legislation to authorize the Securities and Exchange Commission to regulate all securities-related over-the-counter derivatives and to raise the eligibility standards for municipalities that want to enter into swaps, the SEC chairman told a House panel yesterday.

Testifying before the House Agriculture Committee, Mary Schapiro warned that Congress should strengthen the proposal in several ways to "avoid regulatory gaps and eliminate regulatory arbitrage opportunities."

Congress should consider modifying the proposal "so that all securities-related OTC derivatives are regulated more like securities and commodity and other non-securities related OTC derivatives are regulated more like futures," she said in written testimony. "At the core of this approach is the principle that similar products should be regulated similarly, or equivalently, if possible."

Photo: Bloomberg News

She also called on lawmakers to strengthen the SEC's existing anti-fraud authority over all securities-related OTC derivatives, beyond what Treasury is proposing. This authority is essential to policing fraud in the securities markets, she said, and requires examination authority over all entities dealing in securities-related swaps, direct access to real-time data on them, as well as comprehensive anti-fraud and anti-manipulation rulemaking authority for these swaps.

Schapiro also said she is in agreement that the SEC, the Commodity Futures Trading Commission, and other regulators that she be given greater authority to write business conduct standards that would impose limits in situations in which a swap dealer is selling OTC derivatives to smaller or less sophisticated market participants, "including certain municipalities." This authority would allow the SEC to write rules to address abuse that does not necessarily rise to the level of fraud, a knowledgeable source said.

Schapiro's push for greater regulatory authority for the SEC reflects an attempt to convince lawmakers to craft a much larger regulatory role for the commission than in the Treasury proposal. The 115-page draft legislation Treasury sent to Congress this summer would limit the SEC's authority, in part by significantly narrowing the current legal definition of securities-based swaps.

Under the Treasury plan, the SEC would generally only regulate swaps that are based on a narrow-based security index that include nine or less securities, while muni interest rate and other swaps based on a broad-based index would be regulated by the Commodity Futures Trading Commission.

It was unclear yesterday if the SEC would be successful in its attempt for greater regulatory authority. But other federal officials indicated there will be a fight.

Speaking at the BondEdge Fixed Income Summit here, Kim Wallace, Treasury's assistant secretary for legislative affairs, said that coordinating the "turf battle" over jurisdiction between the SEC and CFTC for OTC derivatives remains a hurdle. "That will be part of the entertainment in this process," he said.

However, Schapiro told the agriculture panel that the SEC and CFTC have reached common ground on several issues, including greater authority for regulators to establish business conduct standards.

Separately yesterday, a top member of the Senate Banking Committee unveiled a bill to regulate derivatives, the first legislation of its kind from the chamber's main financial services oversight committee.

Sen. Jack Reed, D-R.I., who chairs the Senate Banking subcommittee on securities, insurance, and investment, introduced a bill that would move standardized over-the-counter derivatives trades onto central clearing platforms, require prudential supervision of all "significant derivatives traders" and establish reporting and business conduct requirements for all trades and trading parties.

In a statement, Reed said the bill "goes far beyond" the derivatives legislation proposed by the Obama administration "by covering all derivatives trading, not just swaps." The statement said Reed's bill would also enlist the CFTC and SEC to help bank regulators write rules on capital and margin requirements for banks that are considered "significant market participants."

Observers said it was not yet clear how much traction the bill would gain in the committee.

Patrick Temple-West and the American Banker's Emily Flitter contributed to this story.

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