[Congressional Record Volume 155, Number 171 (Wednesday, November 18, 2009)]
[Senate]
[Pages S11484-S11485]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




              FINANCIAL REGULATORY REFORM AND DERIVATIVES

  Mr. GREGG. Mr. President, the journalist H.L. Mencken once observed 
that, ``complex problems have simple, easy to understand, wrong 
answers.'' And, though modern history has amply demonstrated the 
resistance of complex political and economic systems to the easy answer 
of centralized control, we try time and again to apply top-down 
solutions to our multifaceted problems. This conflict is brought into 
no sharper light than by Congress' current efforts at financial 
services reform; particularly those directed at the labyrinthine world 
of the multi-trillion dollar derivatives trade.
  Derivatives are a vital and complex component of modern financial 
markets, making it imperative that reform be done right--without damage 
to the

[[Page S11485]]

twin pillars of innovation and capital formation.
  The question as to how derivatives should be regulated is not easy to 
answer, but Congress should start with some guiding principles. First, 
derivatives regulation should seek to foster a robust, competitive, and 
liquid marketplace. Second, systemic counter-party risk exposure must 
be reduced by incentivizing central clearing and increasing reporting 
requirements to promote transparency. Third, regulation must preserve 
the ability to engage in bilateral customized transactions for risk 
management. Finally, we must coordinate our efforts with the 
international community to prevent global regulatory arbitrage and the 
flight of capital to less regulated jurisdictions.
  Unfortunately, the regulatory reform proposals making their way 
through both chambers of Congress fail to take into account the 
intricacies of this dynamic financial product and expose a fundamental 
misunderstanding of the way in which the marketplace works. Congress 
must think through the significant, unintended consequences before we 
act to mandate that all Over-the-Counter--OTC--derivatives be centrally 
cleared and executed on exchanges or cash collateralized, as well as 
subjecting end-users to capital charges. By de-incentivizing companies 
to use these risk management tools, such proposals will have the 
perverse effect of increasing business risk and raising costs.
  The proposals advocated for by the U.S. Treasury and Chairman of the 
Senate Banking Committee, Senator Christopher Dodd, seem to provide too 
many government mandates and not enough flexibility. The proposed 
regulatory structure for OTC derivatives is built on an inadequate 
foundation lacking the staff, expertise, technology, and resources 
needed to provide truly robust oversight. Clearing and exchange-trading 
requirements do not accommodate the need for customized transactions. 
Capital and margin requirements threaten to lock up liquidity. Lack of 
international coordination guarantees a flight of capital away from our 
shores.
  Derivatives may not be part of the Main Street vernacular, they may 
be unfamiliar to the local car dealership, but the manufacturers that 
supply those dealerships know them well. Derivatives provide businesses 
with access to lower cost capital, enabling them to grow, invest, and 
retain and create new jobs. With the unemployment rate at 10.2 percent 
nationally, this is no time to increase uncertainty and business costs.
  Congress must be mindful of the mobility of capital in the global 
marketplace as well. Without a proper regulatory balance, capital can 
and will accept higher risk for less onerous regulation. We must 
maintain incentives for business to participate in a large and liquid 
OTC derivative market, while promoting global coordination to minimize 
regulatory arbitrage and systemic risk.
  Under current proposals, capital requirements that will be imposed on 
OTC dealers will pass on additional cost to end-users. Coupling these 
capital costs with a decreasing ability to customize transactions could 
result in sharply lower usage by end-users. Given that 94 percent of 
Fortune 500 companies utilize customized OTC derivatives to manage 
macro-economic risk, providing less certainty to corporate balance 
sheets will severely undermine confidence in the American marketplace.
  Further, the proposal to mandate exchange trading makes little sense 
in the bespoke OTC derivatives market. The basic assumption of exchange 
trading reflects the use of standard products. OTC derivates by their 
very nature are not always standard. In the real world, mandating use 
of an exchange would inhibit the use of such customized derivates that 
are useful financial management tools to hedge extremely specific 
risks. Bespoke derivatives cannot always be substituted with exchange 
traded or standardized OTC products. Even attempting to craft a carve-
out for such derivatives raises the concern of whether the U.S. 
Securities and Exchange Commission and Commodities Future Trading 
Commission could agree on what should be traded.
  Another red flag raised by the circulating proposals is the 
unintended consequence of segregating variation margin. The more 
capital a dealer has to set aside to purchase an asset, the fewer 
assets it can purchase. Heightened capital requirements restrict a 
dealer's ability to generate returns on its capital or provide loans to 
Main Street businesses, students heading to college, or families 
seeking a mortgage. It also does not protect end users or reduce 
systemic risk in any demonstrable way.
  Corporate scandal and economic failure have provided such a 
regulatory catalyst many times in the past. It is alarmingly 
reminiscent of 2002, when Congress enacted Sarbanes-Oxley; introducing 
a host of new compliance requirements for accounting, corporate 
governance, and financial disclosure. But, in the years since the 
legislation took effect, the overhaul has come to be widely regarded as 
overly complex, unduly burdensome, and a severe disadvantage to 
American businesses in the global marketplace.
  Congress should be instructed by the lessons of the past and not add 
such regulations that will impede capital formation. The simple, easy, 
but ultimately wrong answer is to issue a government mandate for every 
perceived problem. Thinking through the unintended consequences of 
overregulation and trusting market solutions is more difficult, but it 
is ultimately the only way to preserve the innovation that powers 
American markets.

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