[Congressional Record Volume 144, Number 106 (Friday, July 31, 1998)]
[Extensions of Remarks]
[Page E1505]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]


                   REGULATION OF DERIVATIVE PRODUCTS

                                 ______
                                 

                          HON. JAMES A. LEACH

                                of iowa

                    in the house of representatives

                         Friday, July 31, 1998

  Mr. LEACH. Mr. Speaker, in the past fortnight, the Banking Committee 
has held two hearings on the regulation of over-the-counter markets in 
derivative and hybrid instruments. Bankers and businessmen, farmers and 
fund managers use these esoteric financial products, whose value 
derives from an underlying asset like a government bond or the income 
stream from a loan, to mitigate risk from changes in commodity prices 
or interest rates. Few Americans have ever come into contact with one 
of these instruments, but every American with a pension fund or money 
in a bank has been affected by them.
  I scheduled the hearings in response to an unusual circumstance: 
three of the four government agencies which have responsibility for 
overseeing the derivatives market place--the Federal Reserve Board, the 
Treasury Department, the Securities and Exchange Commission--have come 
to the conclusion that the other principal regulator, the Commodity 
Future Trading Commission, has embarked on a regulatory path at odds 
with the U.S. national interest.
  The Fed's, Treasury's and the SEC's concerns about a rogue regulator 
were touched off by a long and detailed request for public comment on 
OTC derivatives trading practices issued in May by the Commodity 
Futures Trading Commission. OTC derivatives have some characteristics 
of futures--like futures, they are used to manage risk--but the 
Congress has never defined them as such and, in 1992, directed the CFTC 
to exempt them from the Commodity Exchange Act, which the CFTC 
administers. Although the CFTC stated in its release that its 
questionnaire was merely a fact-finding exercise, to everyone else it 
had the potential of radically changing the existing laws and 
regulations with the unsettling prospect that existing contracts could 
be invalidated. To the market place, the CFTC inquiry had all the tell-
tale signs of precipitating a regulatory regime that would cause a 
market currently dominated by American firms and under American law to 
go off shore.
  The current laws and regulations that govern the trading on our 
futures exchanges and over-the-counter markets are a tissue of 
ambiguities and exceptions--a veritable elysian field for lawyers. It 
is not an exaggeration to say a unilateral CFTC change in the 
definition of a swap, which was clearly contemplated in its public 
comment request, could invalidate thousands of similar contracts held 
by banks and other financial institutions and businesses here and 
abroad, worth billions of dollars. Such a stroke would jolt the world's 
financial system and force our financial institutions to take this 
innovative and profitable business to a foreign location, whether it be 
London, Tokyo or the Caribbean.
  For better or worse, the word ``paradigm'' has in recent years become 
one of Washington's most fashionable expressions. At the risk of 
contributing to its overuse, it would appear that the interagency 
dispute that has been revealed is reflective of two separate but 
overlapping paradigms, one stemming from perspectives grounded in a 
career in law, the other from careers rooted in finance and economics.
  Chairman Born's paradigm, which involves a legalistic reading of the 
Commodity Exchange Act, has certain merit in the abstract. But in the 
real world of trading, a world shaped by history and legislative 
intent, world not frozen in footnotes, the economic paradigm should be 
considered the dominant one. Indeed, the extraordinarily original 
analysis Chairman Greenspan provided the Banking Committee last week 
amounts to an essay that should be required reading for every college 
economics student.
  The Greenspan paradigm will not be found in any legal tome because it 
captures a dynamic and fast-evolving situation, whereas the legalistic 
Born paradigm, by its very nature, must look backward for precedent.
  In brief, Chairman Greenspan argued that, as currently implemented, 
the Commodity Exchange Act was not an appropriate framework for 
professional trading of financial futures. The CEA, he noted, was 
enacted in 1936 primarily to curb price manipulation in grain markets 
and its objectives haven't changed since then. As a consequence, we are 
applying today crop-futures regulation to instruments for which it is 
wholly inappropriate. The Greenspan view is that the financial 
derivatives markets are encumbered with a regulatory structure devised 
for a wholly different economic process, a structure that impedes the 
efficiency of the market system and slows down improvement in living 
standards.

  This is rich food for thought for Congress. The interagency 
regulatory Donnybrook is unseemly, generating market tension and 
uncertainty. It shows that our system may need a fix. If a single 
regulator can roil markets with an institutionally self-serving and 
whimsical reading of the law, it is time to have a good look not only 
at the statutes but at who enforces them.
  The ``who'' and the ``what'' of regulation in this area must be 
revisited, with an understanding that it is more important for 
regulation to be adapted to markets than for markets to be hamstrung by 
regulation. A balance involving legal certitude, especially of 
contracts, must be established. This balance must be flexible enough to 
accommodate innovation, but also legally firm when it comes to issues 
like fraud.
  Chairman Born's July 24 letter to Chairman Smith in which she states 
``the Commodity Futures Trading Commission . . . will not propose or 
issue'' OTC derivative regulations until the Congress convenes in 
January 1999 momentarily muted the crisis. But, in effect, her offer 
isn't much of a concession. It is far short of the agreement Chairman 
Smith believed he had reached--and so said in a press release: ``the 
CFTC will not pursue regulation of over-the-counter (OTC) derivatives 
until Congress has the opportunity to act during CFTC reauthorization 
in 1999.''
  It is my view that it would be preferable to resolve this dispute 
without legislation and, accordingly, I chaired two informal meetings 
with the regulators to attempt to reach an non-legislated solution. But 
given the impasse, I introduced H.R. 4062, which provides a standstill 
on new regulation until the CFTC reauthorization is done. Work on this 
bill has been temporarily suspended to give everyone time for another 
effort at compromise. But if the Agricultural Committees don't address 
the issue, the bill remains on the table for consideration yet this 
year.
  Meanwhile, I am asking the Secretary of the Treasury, in his capacity 
of chairman of the President's Working Group on Financial Markets, to 
undertake a study of our regulations and regulators. The industry, 
academic experts, and other interested parties, including users of 
derivative products, should be given a prominent voice in the study. 
The Treasury Secretary should provide the Group's findings and 
suggestions to the appropriate committees in the House and Senate by 
February 1, 1999, so that the Congress can get an early start on 
rebuilding our market supervision system. Nothing less than the primacy 
of the U.S. financial industry in the world is at stake--along with the 
safety and soundness of our banks and protection of their customers.

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