By Anne Sherry, J.D.
Calling back to the 2009 G20 summit in Pittsburgh, SEC Commissioner Hester Peirce urged attendees at the International Regulators Conference to exercise caution when regulating the derivatives markets. Poorly designed regulations played a part in the financial crisis, she said, and the stakes are higher when mistakes occur at the regulatory level rather than by individual market participants. Peirce added that while it is not always easy to identify badly designed regulations, regulators owe it to the public to examine their own efforts for possible vulnerabilities or distortions.
Regulatory shortcomings. AIG is the poster child for the financial crisis, Peirce said, but not for the often cited reasons. Contrary to the popular narrative, AIG was not unregulated: its life insurance subsidiaries and their involvement in the securities lending program had many regulators, and AIG as a whole had many more. Likewise, the financial crisis “was not neatly attributable to one cause and clearly implicates both the private and the public sectors.”
Peirce noted that it is possible that the Pittsburgh reforms would not have prevented the financial crisis, and that it is important to recognize the limits of those reforms. It is unrealistic to think that the G20 reforms will bring about a world in which everything is centrally cleared. The AIG swaps were not standardized, so central clearing would be unlikely. The G20 reforms also could fail to address factors that were critical in the last crisis or likely to create the next.
Central clearing is also not a panacea, Peirce continued, citing the recent member default at Nasdaq Clearing. This default was relatively simple—it involved a single person trading in the Nordic and German power markets. Regulators must envision a more complex default involving interconnected members, large portfolios, or more complicated products, and occurring during a time of market stress.
Peirce cautioned that regulators are at an informational disadvantage relative to the markets, a fact that is easy to forget in the wake of a crisis. Regulators’ errors in judgment also cause more problems than those of individual market participants. For example, assigning an inappropriate risk weight to certain assets or sovereign debt can create severe consequence at the worst time.
The SEC’s role going forward. The commissioner closed by addressing what she called the elephant in the room: the SEC’s failure to promulgate its framework for security-based swaps. The Dodd-Frank and JOBS Act mandate created “approximately 100 good excuses” for this delay, Peirce said, and she noted that Chairman Clayton has made it a priority to finish the regulatory framework for security-based swaps. In early October, the agency reopened the public comment period on its proposal on capital, margin, and segregation requirements for security-based swap dealers and major security-based swap participants.
Beyond that first step, the SEC has adopted many of its security-based swap dealer rules and finalized the security-based swap reporting rules, but compliance is conditioned on the finalization of three remaining security-based swap dealer rules. Peirce is guided by three principals throughout this process: remaining open to reconsidering elements of the proposed or final requirements; articulating clear rules and Commission-level guidance rather than relying on no-action relief or staff-level guidance; and accounting for the challenges market participants will face as they come into compliance with this new, complicated regime. The SEC can mitigate the compliance burden on parties such as dealers’ counterparties by ensuring that the compliance deadlines allow for adequate preparation.
Peirce also seeks solutions to other issues that may prevent an efficient transition to Title VII regulation. For example, she would like the SEC to address questions around the ability of dealers to rely on representations made in connection with CFTC external business conduct requirements and to resolve issues affecting foreign dealers. The SEC may also consider possible alternative approaches to arrange-negotiate-and-execute requirements. Many of these issues will involve joint work with the CFTC and international regulators. When it comes to the SEC’s implementation of Title VII, that will mean substituted compliance with foreign requirements, in Peirce’s view.