[Congressional Record Volume 141, Number 36 (Monday, February 27, 1995)]
[Extensions of Remarks]
[Pages E447-E448]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]


             INTRODUCTION OF DERIVATIVES DEALERS ACT OF 1995

                                 ______


                         HON. EDWARD J. MARKEY

                            of massachusetts

                    in the house of representatives

                        Monday, February 27, 1995
  Mr. MARKEY. Mr. Speaker, today I am introducing the Derivatives 
Dealers Act of 1995. This legislation is aimed at providing a framework 
for improved supervision and regulation of previously unregulated 
dealers and assuring appropriate protections for their customers.
  Today's newspapers report on the disastrous consequences of 
derivatives losses by Barings PLC--one of Great Britain's oldest 
merchant banks. According to these reports, Baring's has lost at least 
$950 million due to unauthorized derivatives trading by a 27-year-old 
trader in its Singapore office. This sorry episode underscores the 
risks inherent in failing to assure that regulators have adequate tools 
on hand to minimize the potential for OTC derivatives to contribute to 
a major disruption in the financial markets, either through excessive 
speculation and overleveraging, or due to inadequate internal controls 
and risk management on the part of major derivatives dealers or end 
users. Despite the best efforts of the Bank of England to rescue 
Barings, apparently the scale of the losses is so great that as 
collapse could not be averted. As a consequence, both European and 
Asian financial markets are in turmoil today. The bill I am introducing 
today will help assure that no similar disaster befalls American 
derivatives dealers or our financial markets.
  Derivatives are financial products whose value is dependent on--or 
derived from--the value of some underlying financial asset such as a 
stock, bond, foreign currency, commodity, or an index representing the 
value of such assets. Some derivatives have been around for many years, 
such as the exchange-traded futures and options used by investors and 
dealers seeking to hedge positions taken in the stock and bond markets, 
or to speculate on future market movements.
  Within the last few years, however, such exchange-traded futures and 
options have been supplemented by a vast and dizzying array of over-
the-counter [OTC] derivatives. These include forwards, swaps, options, 
swaptions, caps, floors, and collars that may be linked to the 
performance of the Japanese stock market, the dollar-deutschemark 
exchange rate, the S&P 500, or virtually any other asset. Today, the 
total outstanding value of the principal underlying such over-the-
counter derivatives is estimated to be over $12 trillion.
  The dynamic growth of the OTC derivatives market is the direct result 
of developments in computer and telecommunications technology and 
breakthroughs in modern portfolio management theory that have created a 
new world of cyber-finance that is reshaping U.S. and global financial 
markets. These new financial instruments are an important component of 
modern financial activity and provide useful risk management tools for 
corporations, financial institutions, and governments around the world 
seeking to respond to
 fluctuations in interest rates, foreign currency exchange rates, 
commodity prices, and movements in stock or other financial markets.

  While OTC derivatives are frequently used to hedge foreign currency 
or interest rate risks or to lower borrowing costs, there has been a 
proliferation of increasingly exotic, customized financial contracts or 
instruments that enable dealers and end users to make speculative 
synthetic side bets on global financial markets. This development has 
raised concerns over the potential for OTC derivatives to increase, 
rather than reduce risk of financial loss or contribute to a future 
financial panic. In addition, the concentration of market-making 
functions in a small number of large banks and securities firms, the 
close financial interlinkages OTC derivatives have created between each 
of these firms, and the sheer complexity of the products being traded 
raise serious concerns about the potential for derivatives to 
contribute to serious disruptions in the fabric of our financial 
system. My bill will help assure that Federal regulators have the 
ability to effectively monitor the activities of certain heretofore 
unregulated derivatives dealers.
  In addition, my bill will help assure that our financial regulatory 
structure includes appropriate customer protections in place in the 
form of full disclosure, accurate financial accounting, appropriate 
sales practices, and restrictions against fraudulent or manipulative 
activity.
  While the Barings PLC disaster underscores the some of the risks and 
dangers associated with derivatives, the Subcommittee on 
Telecommunications and Finance, which I chaired in the last Congress, 
has been closely monitoring the financial derivatives market for the 
[[Page E448]] last 3 years. In June 1992, I wrote to the General 
Accounting Office [GAO] to request a comprehensive study of the 
derivatives market. At that time, the subcommittee noted that the 
trading of new and complex derivative products by financial 
institutions and their customers had greatly increased in recent years, 
creating a corresponding need to assure that knowledge of how to manage 
and oversee the risks associated with these products was keeping pace.
  The GAO derivatives study submitted on May 19, 1994, in response to 
the subcommittee's request, has identified some serious gaps in the 
current legal and regulatory structure relating to OTC derivatives.
  The GAO made a number of important recommendations for reforms in the 
regulation of financial derivatives disclosure, financial accounting, 
and dealer regulation. Of particular concern to me was GAO's finding 
that serious gaps existed in the current legal and regulatory framework 
that allows derivatives dealers affiliated with securities firms or 
insurance companies to largely escape the type of regulations which are 
already in place for derivatives dealers affiliated with banks. GAO 
also identified potential gaps in antifraud and antimanipulation 
enforcement authority, and sales practice regulation. In response, the 
GAO recommended that this ``black hole'' be plugged by granting a 
Federal regulator, such as the Securities and Exchange Commission, 
appropriate authority to conduct examinations and set capital standards 
for these currently unregulated dealers.
  The subcommittee closely examined the derivatives markets and the 
findings and recommendations of the GAO study in oversight hearings 
held on May 10, 19, 25, and July 7th of last year. Based on the 
information gathered in the course of these hearings and other 
inquiries, I have crafted a piece of legislation which would close the 
most glaring legal gap affecting the derivatives markets--the presence 
of virtually unregulated OTC derivatives dealers in the market.
  This bill will close the regulatory ``black hole'' that has allowed 
derivatives dealers affiliated with securities or insurance firms to 
escape virtually any regulatory scrutiny. It will give the SEC the 
tools needed to monitor the activities of these firms, assess their 
impact on the financial markets, and assure appropriate protections are 
provided to their customers against any fraudulent or abusive 
activities. It is not a radical restructuring of the derivatives 
market; it is focused laser-like on the real gaps that exist in the 
current regulatory framework that need to be closed, and closed now 
before we have our own Barings PLC disaster right here in America.
  I urge my colleagues to cosponsor and support this important 
legislation.


                          ____________________