[Congressional Record Volume 145, Number 165 (Friday, November 19, 1999)]
[Extensions of Remarks]
[Pages E2510-E2511]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




             INTRODUCTION OF DERIVATIVES MARKET REFORM ACT

                                 ______
                                 

                         HON. EDWARD J. MARKEY

                            of massachusetts

                    in the house of representatives

                      Thursday, November 18, 1999

  Mr. MARKEY. Mr. Speaker, today I am joining with the Senator from 
North Dakota (Mr. Dorgan) in introducing the Derivatives Market Reform 
Act.
  In recent years, over-the-counter (OTC) derivative financial products 
have become an important component of modern financial markets. They 
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 risks or to lower 
borrowing costs, they can also be used by dealers or end-users to make 
risky and highly speculative synthetic bets on the direction of global 
financial markets. The potential for such derivatives to contribute to 
excessive speculation or leveraging has raised concerns over the 
potential for OTC derivatives to increase, rather than reduce the risk 
of catastrophic financial loss or contribute to a future financial 
panic or meltdown in global financial markets.
  In addition, the concentration of market-making functions in a small 
number of large banks and securities firms, the close financial inter-
linkages 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. The potential for 
the failure of a key market participant to trigger a meltdown--or the 
specter of a potential disruption in the financial markets due to 
highly leveraged and complex investment strategies--was illustrated by 
last years' near collapse of the hedge fund known as Long-Term Capital 
Management (LTCM).
  The LTCM affair has underscored the need for regulators to minimize 
the potential for OTC derivatives to contribute to a major disruption 
in the financial markets, either through excessive speculation and 
over-leveraging, or due to inadequate internal controls and risk 
management on the part of major derivatives dealers or end-users. 
Today, Senator Dorgan and I are introducing legislation in both the 
House and the Senate which would provide for certain targeted 
derivatives market and hedge fund reforms in the aftermath of the LTCM 
affair. Here's what our bill would do:
  First, the bill would define ``derivative'' to include any financial 
contract or other instrument that derives its value from the value or 
performance of any security, currency exchange rate, or interest rate 
(or group of index thereof). With respect to instruments based on 
currency exchange rates, we would exclude the most common type of 
derivative instrument--forward rate contracts--but would include 
foreign currency swaps that have a duration greater than 270 days. 
Securities traded on an exchange or on the NASDAQ, futures or options 
on futures, and bank or savings institutions deposits also would be 
excluded.
  Second, the definition of ``security'' in section 3(a)(10) of the 
Securities Exchange Act of 1934 (``Exchange Act'') would be amended to 
include derivatives based on the value of any security. While options 
on securities already are included within this definition, the 
amendment would bring equity swaps explicitly under the definition of 
``security'' and subject transactions in equity swaps to regulation 
under the Exchange Act.
  Third, persons defined as ``derivatives dealers'' would become 
subject to Securities and Exchange Commission (``Commission'') 
regulation. Derivatives dealers that are not (1) registered broker-
dealers or (2) material associated persons of registered broker-dealers 
that have filed notice with the Commission, would be required to 
register with the Commission and would be subject to Commission 
rulemaking and enforcement authority. Commission rulemaking would focus 
on financial responsibility and related recordkeeping and reporting 
requirements, as well as on the prevention of fraud. Such dealers also 
would be required to become members of an existing registered 
securities association, or any registered securities association that 
may be established for derivatives dealers. Rules adopted by a 
registered securities association would focus on the prevention of 
sales practice abuses and the establishment of internal controls.
  Derivatives dealers that are material associated persons of 
registered broker-dealers would be required, as a general matter, to 
file a form of notice with the Commission. Alternatively, such dealers 
would be permitted to register as a derivatives dealer. Dealers that 
file notice would be regulated indirectly

[[Page E2511]]

through their broker-dealer affiliate. The risk assessment provisions 
already in place under the Exchange Act, which would be amended by this 
bill, would be utilized for this purpose. In addition, the broker-
dealer's net capital would be based, in part, on the derivatives 
activities of its affiliated derivatives dealer. The designated 
examining authority for the broker-dealer would have rulemaking and 
enforcement authority with respect to the derivatives activities of 
both the broker-dealer and the affiliate. The Commission also would be 
authorized to adopt rules designed to prevent fraud.
  Fourth, the bill would require the filing of quarterly reports by 
hedge funds, including a statement of the financial condition of the 
fund, income or losses, cash flows, changes in equity, and a 
description of the models and methodologies used to calculate, assess, 
and evaluate market risk, and such other information as the Commission, 
in consultation with the other financial regulators, may require as 
necessary or appropriate in the public interest or for the protection 
of investors. The Commission is authorized to allow any confidential 
proprietary information to be segregated in a confidential section of 
the report that would be available to the regulators, but would not be 
disclosed to the public.
  Fifth, the bill would also direct the SEC to use its existing large 
trader reporting authority to issue a final large trader reporting 
rule. Congress gave the SEC this authority in the Market Reform Act of 
1990 in order to assure that the trading activities of hedge funds and 
other large traders could be tracked by the SEC for market surveillance 
and other purposes. Nearly 10 years later, the SEC has failed to issue 
a final rule, and the draft rules it issued years ago are gathering 
dust. Our bill would change that.
  Sixth, the bill would reinstate the intermarket coordination 
reporting requirements established by Section 8(a) of the Market Reform 
Act of 1990. This reporting requirement, which expired in 1995, was 
intended to promote cooperation by the various financial regulators by 
requiring them to report to Congress on an annual basis on their 
efforts to coordinate regulatory activities, protect payment systems 
and markets during emergencies, establish adequate margin requirements 
and limits on leverage, and other matters affecting the soundness, 
stability, and integrity of the markets.
  Adoption of this bill would 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 would require hedge funds to provide some public 
reporting regarding their holdings. It is not a radical restructuring 
of the derivatives market or of the hedge fund industry; it is focused 
laser-like on the real gaps that exist in the current regulatory 
framework that need to be closed in the aftermath of the LTCM affair.
  I urge my colleagues to cosponsor and support this important 
legislation.

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