June 10, 2010
Good afternoon. I thank the Quebec AMF for hosting this IOSCO conference and for inviting me to participant on this panel. I also thank my fellow panelists and Hector Sants for moderating our panel. I am honored to be here with Mary Schapiro, Chairman of the U.S. Securities and Exchange Commission.
In 2008, the global financial system failed the test. The financial regulatory system failed the test. So many people all over the world who never had any connection to derivatives or exotic financial contracts had their lives hurt by the risks taken by financial actors.
Over-the-counter derivatives in particular were at the center of the 2008 financial crisis. In the United States, taxpayers bailed out AIG with $180 billion when that company’s ineffectively regulated $2 trillion derivatives portfolio, managed from London and cancerously interconnected to other financial institutions, nearly brought down the financial system. As we later learned, much of the bailout money flowed through AIG to U.S. and European banks.
As capital and risk know no geographical boundaries, the nature of today’s marketplace demands a coordinated, international approach. We’re going to need to work closely together to reform and repair the regulatory system.
Global reform includes three essential components.
First, we must bring comprehensive regulation to derivatives dealers. Dealers should be required to have sufficient capital and to post collateral on transactions to protect the public from bearing the costs if dealers fail, as American taxpayers were forced to do with AIG. Dealers should be required to meet robust standards to protect market integrity and lower risk and should be subject to stringent record-keeping requirements.
Second, we must bring sunshine to the over-the-counter derivatives marketplace by requiring standard products to be traded on transparent exchanges or other similar trading venues. Transparency brings better pricing and lowers risk for all parties to a derivatives transaction. Trading venues are also the best way to bring reliable pricing data and essential liquidity so that clearinghouses can manage the risk of clearable contracts.
Third, to further lower risk to the economy, standard over-the-counter derivatives should be brought to clearinghouses. Clearinghouses act as middlemen between two parties to a transaction and guarantee the obligations of both parties. Clearinghouses in the futures markets have been around since the late-19th Century and have functioned both in clear skies and during stormy times – through the Great Depression, numerous bank failures, two world wars and the 2008 financial crisis – to lower risk to the economy. While U.S. taxpayers were not required to cover market exposures on any cleared futures transactions, they had to bail out AIG and others in part to cover uncollateralized and uncleared derivatives contracts.
Trading and clearing requirement will be only as effective as they are comprehensive. Regulators and legislators across the world should resist attempts to add exemptions and loopholes to these much-needed protections.
The U.S. Senate and House of Representatives have each passed historic bills to implement these three principles. The two bodies began meeting earlier today to produce a compromise bill that I am hopeful will be signed by President Obama soon.
The time has come to enact these essential reforms of the over-the-counter derivatives market. Effective reform cannot be accomplished by any nation alone. It will require a comprehensive, international response. The effectiveness of reform depends on our ability to cooperate and find general consensus on this much needed regulation. If we fail, we will leave the global economy and the global citizenry at risk.
Last Updated: January 18, 2011