The crisis of the past 20 months has exposed critical gaps and weaknesses in our financial regulatory system. As risks built up, internal risk management systems, rating agencies and regulators simply did not understand or address critical behaviors until they had already resulted in catastrophic losses. Those failures have caused a dramatic loss of confidence in our financial institutions and have contributed to a severe recession.

Last March, Secretary Geithner laid out new regulatory rules of the road to ensure we never face a crisis of this magnitude again. An essential element of reform is the establishment of a comprehensive regulatory framework for over-the-counter derivatives, which under current law are largely excluded or exempted from regulation.

As the AIG situation has made clear, massive risks in derivatives markets have gone undetected by both regulators and market participants. But even if those risks had been better known, regulators lacked the proper authorities to mount an effective policy response.

Today, to address these concerns, the Obama Administration proposes a comprehensive regulatory framework for all Over-The-Counter derivatives.

Moving forward, the Administration will work with Congress to implement this framework and bring greater transparency and needed regulation to these markets. The Administration will also continue working with foreign authorities to promote the implementation of similar measures around the world to ensure our objectives are not undermined by weaker standards abroad.

Objectives of Regulatory Reform of OTC Derivatives Markets

• Preventing Activities Within The OTC Markets From Posing Risk To The Financial System – Regulators must have the following authority to ensure that participants do not engage in practices that put the financial system at risk:
• The Commodity Exchange Act (CEA) and the securities laws should be amended to require clearing of all standardized OTC derivatives through regulated central counterparties (CCP):

• • CCPs must impose robust margin requirements and other necessary risk controls and ensure that customized OTC derivatives are not used solely as a means to avoid using a CCP.

• • For example, if an OTC derivative is accepted for clearing by one or more fully regulated CCPs, it should create a presumption that it is a standardized contract and thus required to be cleared.

• All OTC derivatives dealers and all other firms  who create large exposures to counterparties should be subject to a robust regime of prudential supervision and regulation, which will include:

• • • Conservative capital requirements
    • Business conduct standards
    • Reporting requirements
    • Initial margin requirements with respect to bilateral credit exposures on both standardized and customized contracts
• Promoting Efficiency And Transparency Within The OTC Markets — To ensure regulators would have comprehensive and timely information about the positions of each and every participant in all OTC derivatives markets, this new framework includes:

• Amending the CEA and securities laws to authorize the CFTC and the SEC to impose:

• • • Recordkeeping and reporting requirements (including audit trails).
    • Requirements for all trades not cleared by CCPs to be reported to a regulated trade repository.
      • CCPs and trade repositories must make aggregate data on open positions and trading volumes available to the public.
      • CCPs and trade repositories must make data on individual counterparty's trades and positions available to federal regulators.
    • The movement of standardized trades onto regulated exchanges and regulated transparent electronic trade execution systems.
    • The development of a system for the timely reporting of trades and prompt dissemination of prices and other trade information.
    • The encouragement of regulated institutions to make greater use of regulated exchange-traded derivatives.

• Preventing Market Manipulation, Fraud, And Other Market Abuses The Commodity Exchange Act (CEA) and securities laws should be amended to ensure that the CFTC and the SEC have:

• • Clear and unimpeded authority for market regulators to police fraud, market manipulation, and other market abuses.
  • Authority to set position limits on OTC derivatives that perform or affect a significant price discovery function with respect to futures markets.
  • A complete picture of market information from CCPs, trade repositories, and market participants to provide to market regulators.

• Ensuring That OTC Derivatives Are Not Marketed Inappropriately To Unsophisticated Parties Current law seeks to protect unsophisticated parties from entering into inappropriate derivatives transactions by limiting the types of counterparties that could participate in those markets.  But the limits are not sufficiently stringent.

• The CFTC and SEC are reviewing the participation limits in current law to recommend how the CEA and the securities laws should be amended to tighten the limits or to impose additional disclosure requirements or standards of care with respect to the marketing of derivatives to less sophisticated counterparties such as small municipalities.

###

REPORTS

• Letter

US Treasure Department Press Release:

November 14, 2008
HP-1272

PWG Announces Initiatives to Strengthen
OTC Derivatives Oversight and Infrastructure

Washington- The President's Working Group on Financial Markets today announced a series of initiatives to strengthen oversight and the infrastructure of the over-the-counter derivatives market.

Initiatives announced today include the development of credit default swap central counterparties, some of which will commence operations before the end of 2008, and the establishment of a Memorandum of Understanding regarding CDS central counterparties among the Federal Reserve Board of Governors, the Securities and Exchange Commission and the Commodity Futures Trading Commission. The PWG also announced a broad set of policy objectives to guide efforts to address the full range of challenges associated with OTC derivatives and issued a progress summary to provide an overview of the results of ongoing efforts to strengthen the infrastructure of OTC derivatives markets.

The Treasury Secretary serves as chair of the group, which includes the Chairs of the Federal Reserve Board, the Securities and Exchange Commission, and the Commodity Futures Trading Commission. The PWG, working with the Office of the Comptroller of the Currency and the Federal Reserve Bank of New York, has been actively overseeing improvements underway in OTC derivatives markets and the reports issued today identify the progress already made and specific objectives for the relevant supervisors going forward.

Over-the-counter derivatives are integral to the smooth functioning of today's complex financial markets and, with appropriate regulatory oversight and prudent management can enhance the ability of market participants to manage risk. The rapid growth of OTC derivatives markets over the past several years reflects their increasing importance to market participants.

Development of CDS Central Counterparties

The PWG's top near-term OTC derivatives priority is to oversee the successful implementation of central counterparty services for credit default swaps. A well-regulated and prudently managed CDS central counterparty can provide immediate benefits to the market by reducing the systemic risk associated with counterparty credit exposures. It also can help facilitate greater market transparency and be a catalyst for a more competitive trading environment that includes exchange trading of CDS.

At the prompting of the PWG, several potential central counterparty providers have accelerated the development of their efforts. The relevant regulatory authorities are assessing these central counterparty proposals by conducting detailed on-site reviews of risk management and other key design elements. After completing the on-site reviews, regulators expect to proceed toward regulatory approvals and/or exemptions expeditiously and anticipate that one or more CDS central counterparties will commence operations before the end of 2008.

Memorandum of Understanding among the CFTC, SEC and Federal Reserve

To facilitate the regulatory approval process and to promote more consistent regulatory oversight, the Board of Governors of the Federal Reserve System, the Securities and Exchange Commission and the Commodity Futures Trading Commission today signed a Memorandum of Understanding. The Memorandum of Understanding establishes a framework for consultation and information sharing on issues related to CDS central counterparties.

The PWG's Policy Objectives for OTC Derivatives

The PWG is announcing a set of additional policy objectives to guide efforts to address challenges associated with OTC derivatives, consistent with the recommendations of the Financial Stability Forum.

U.S. and foreign supervisors embarked on an effort in 2005 to improve how market participants manage their OTC derivatives operations, which had not matured sufficiently to support increased trading volumes. These efforts sought to enhance other elements of the market infrastructure, reduce systemic risk and address operational risks that have accompanied the growth of OTC derivatives.

In light of recent developments, the PWG is issuing broader objectives than those that motivated the PWG's previous OTC derivatives recommendations in the March 13 PWG Policy Statement on Financial Market Developments.

The PWG has established the following policy objectives:

1) improve the transparency and integrity of the credit default swaps market;

2) enhance risk management of OTC derivatives;

3) further strengthen the OTC derivatives market infrastructure;

4) strengthen cooperation among regulatory authorities.

The agencies in the PWG will work with other regulators and market participants to achieve these goals over the next several months. Where necessary, they will support legislative change.

REPORTS

• MOU
• Progress Summary
• Policy Objectives