Monday, August 30, 2010

SEC-CFTC Roundtable on Dodd-Frank Derivatives Regulations Focuses on Governance and Risk Management

At the recent CFTC-SEC roundtable, CFTC Director of the Division of Clearing and Intermediary Oversight Radhakkrishnan said that Dodd-Frank mandates clearing as many OTC derivatives as possible and bringing transparency to these products through the listing of them on exchanges and swaps execution facilities. The Commission has to make a determination as to whether a group of swaps has to be cleared. But if the Commission makes a determination that said this class of swaps has to be cleared but nobody wants to clear it, and let's say nobody wants to clear it, then it won't be cleared and it won't be traded. It is thus important to ensure that the governance structures take care of the conflicts of interest to make sure that the mandate of Congress is not blocked. Mr. Kastner of SDMA said this issue goes directly to the Lynch Light section 726. If there is not proper governance, he said, some derivatives clearing organization may refuse to engage.

SDMA believes that the Commissions must ensure that the risk committees of these derivatives clearing organizations are transparent such that we know who the membership is and that decisions on whether to permit new clearing members and whether to permit new products to be listed are transparent and readily appraisable.

Ms. Slavkin of the AFL-CIO said that, in addition to independence and transparency, it is important to have real experts on the board who understand the risks that exist within a clearinghouse and are prepared to perceive potential risks that may arise in the system down the road and address them. Similarly, former Fed Governor Kroszner said the best way to ensure that experts have input into risk management decisions is to establish a transparent process. It would also be valuable for principles to be outlined in advance of what types of contracts can come onto exchanges and how the decision process will be made. Because one of the goals of Dodd-Frank is a migration of some of these contracts onto essentially bigger platforms. Ms. Slavkin believes that providing a roadmap for how to do that will help to encourage market participants to restructure contracts to make them in a way that they will be more readily clearable.

According to CFTC Special Counsel Schnabel, the Commissions must figure out how to not inject systemic risk into the clearing and listing of swaps, but then balance that against the systemic risk that would exist if bilateral swaps are not cleared or listed because of certain incentives. SIFMA said that ultimately the risk managers of the clearinghouse are the ones who need to figure out how to manage these risks and manage these conflicts. SIFMA encouraged the CFTC and the SEC to reach out to those risk managers to get their direct views on how these risks and these conflicts are best managed. The primary purpose of Dodd-Frank is to reduce systemic risk, said SIFMA, and that risk will now be concentrated primarily in the clearing houses, and it is critical that the regulators get the risk management correct.

Echoing these sentiments, Fed. Gov. Kroszner said that the success of clearinghouses is because of their success in managing risks. The Commissions should refrain from forcing types of contracts that cannot be properly risk managed onto the exchanges by using certain criteria that will undermine risk management. They must be tough about risk management, he said, and sometimes that means setting very tough criteria that some institutions and individuals may not like. We are betting the system on the stability of these clearinghouses, emphasized the former Fed official, and thus the clearinghouses must be seen as bulletproof or as near to bulletproof as any private institution can be.