WASHINGTON — Treasury Secretary Tim Geithner yesterday provided lawmakers with details of proposed regulatory reforms designed to contain systemic risk to the economy, including requiring non-standardized derivatives to meet certain standards, requiring the registration of hedge funds, and strengthening the regulation of money market funds to reduce credit and liquidity risks.

Speaking for the second time this week before the House Financial Services Committee, Geithner also laid out more detailed plans for dealing with non-bank financial institutions in severe distress that pose systemic risks. He sent draft legislation for that authority to Congress Wednesday night.

Geithner told the lawmakers that the financial system needs “better, stronger, tougher regulation,” which would expand to over-the-counter derivatives, money market funds, and hedge funds.

“We want to work with Congress to put in place fundamental reforms that create a stronger, more stable system, with much stronger protections for consumers and investors, and a more streamlined, consolidated, and simple oversight framework,” he said.

The derivatives reforms Geithner outlined made clear that credit default swaps would be cleared through “central counterparties,” or exchanges that would ensure parties on both sides of a derivative contract hold enough capital to meet their obligations. 

Some lawmakers raised the idea of banning CDS altogether. But Geithner said such regulation would be “very hard” and that the market would find a way around the ban.

Asked by Rep. John Campbell, R-Calif., about fixed-income OTC products, Geithner said the clearing requirements would only apply to standardized contracts.

“Our proposal is really concentrated on the over-the-counter derivatives market, not just credit derivatives, but a whole range of products where there has been a huge amount of standardization,” Geithner said. The regulation “would still preserve the capacity for the more specialized tailored products,” he added.

Industry groups have worried that muni interest rate swaps would be required to meet contract specifications and clear on an exchange. The muni market uses swap contracts specific to the parties involved.

However, Geithner made clear that non-standardized derivatives contracts would not be required to be cleared on an exchange in line with the legislation the House Agriculture Committee approved in February. The legislation allows for highly specified OTC derivatives, which trade infrequently, to be exempted from clearing on an exchange.

A market participant with expertise in muni interest rate swaps said market participants will need to see the final details of Geithner’s proposals to be certain that these interest rate swaps are exempted.

Muni CDS could be required to clear on an exchange because the contract specifications are similar to other CDS, she said, though it is unlikely muni CDS will be included in initial regulations.

However, the Treasury secretary indicated that muni derivatives, like other non-standard derivatives, will be required to report to trade repositories and to meet standards for documentation and confirmation of trades, netting, collateral, margin practices, and close-out practices.

Geithner said, “all advisers to hedge funds, private equity funds, and venture capital funds with assets under management over a certain threshold should be required to register with the [Securities and Exchange Commission].”

He also called for “strengthening the regulatory framework around money market funds” to reduce the risk of rapid withdrawals.

“We believe that the SEC should strengthen the regulatory framework around money market funds in order to reduce the credit and liquidity risk profile of individual MMFs and to make sure the MMF industry as a whole is less susceptible to runs,” he said. 

Treasury Secretary Tim Geithner spent three hours Thursday providing Congress with more details on his vision for regulatory reform, but managed to evade the central question.

Though pressed several times, Geithner did not identify which agency should oversee companies judged to pose a systemic risk to the economy.

Though the easy answer appears to be the Federal Reserve Board – and Treasury proposed this week to let the central bank determine which firms pose systemic risks – Geithner pointedly avoided committing to the Fed.

Instead, he said Treasury was open to a range of approaches, while reiterating the dangers of giving one agency too much power.

“We are open to looking at a range of suggestions for how that authority should be framed and where that should be lodged in the system,” Geithner said. “It needs to be vested in an independent supervisory authority. I do not believe it should be pulled together in one independent agency. I think too much concentrated power for all that regulatory authority would be not a sensible thing for the country.”

Geithner’s response is likely at least partly political. Though Frank has endorsed giving the Fed systemic risk oversight, Senate Banking Committee chairman Chris Dodd and Sen. Richard Shelby, the panel’s lead Republican, have expressed serious reservations about the central bank.

But exactly what other choice Geithner has in mind is unclear. He ruled out considering the Treasury for such authority, and cast doubt on the effectiveness of an oversight board.

“You know, in a fire, the fire station needs to understand the neighborhood,” he said. “It needs to know the neighborhood it’s operating in. And you don’t want it to have to convene a committee before it can get the engines out of the station.”

Some lawmakers have also suggested creating a new regulator to handle those responsibilities, but Frank and other lawmakers have said that would take too much time.

Republicans, meanwhile, used the hearing to attack Geithner’s plan, which would also give systemic resolution powers to the Federal Deposit Insurance Corp. GOP members argued that by identifying which institutions were systemically important, Treasury would essentially designate those institutions as “too big to fail.”

“If the entities that are subject to this authority were seen to be as too big to fail, without clear signals indicating what the consequences are for the creditors and the counterparties, we could really end up doing a heck of a lot more harm than good,” said Rep. Scott Garrett, R-N.J. “So forgive me if I’m still a skeptic when I hear if we only have a systemic regulator that this will never happen again, especially if moral hazard is institutionalized with an entire new designation of systemically important institutions that it will never happen again. We will only be encouraging that it will happen again in some future time.”

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.