A group of academics and financial industry players is calling on the U.S. Congress to reform the oversight of the over-the-counter derivatives markets based around regulated, international clearinghouses.

In a letter to the Congressional committees in charge of financial industry regulatory reform in the US, the Committee on Capital Markets Regulation has proposed an approach to reforming the regulatory oversight of derivatives markets that it says will reduce systemic risk in the financial system, through greater use of derivatives clearinghouses that are overseen by the Federal Reserve.

The committee says its members agree that:
• derivatives trades should be required to be conducted through clearinghouses;

• clearinghouses must be regulated to ensure that they require sufficient margin and use other appropriate risk management techniques, and that the U.S. Federal Reserve should be that regulator;

• contracts should be subject to central clearing requirements only if they are standardized and liquid, but customized contracts should still be allowed;

• all standardized and liquid derivatives contracts that only involve clearinghouse members should be centrally cleared;

• clearinghouses should be international in scope;

• there should not be limitations on who can own clearinghouses;

• exchange trading of derivatives should not be required, but should be encouraged; and

• regulators of financial institutions should carefully scrutinize the adequacy of capital requirements for non-centrally cleared derivatives contracts and mandate minimum capital levels to ensure sufficient reserves against the risk these contracts create.

“Meaningful financial regulatory reform depends on reducing the risks posed by over-the-counter derivatives. We’ve all heard the charges that on the topic of derivatives, there is substantial disagreement among industry participants. Nonetheless, the atmosphere of this debate has changed dramatically since last spring,” said Prof. Hal Scott, president and director of the CCMR.

“The committee includes a diverse array of financial market participants with diverse views on many financial and market related issues, but as our letter and release demonstrate, there is now agreement on many of the core problems and the needed solutions. Specifically, committee members agree that the most effective approach to reducing systemic risk centers on well-capitalized, closely monitored and effectively regulated clearinghouses comprised of market participants. Such clearinghouses will spread out the risk of counterparty defaults, thus avoiding chain reactions of financial institution failures,” he added.

“There also is a widespread conviction that monitoring and regulating those clearinghouses should be entrusted to no less knowledgeable or experienced an institution than the Federal Reserve. Our letter amounts to an urgent plea to Congress to get on with this vital mission as quickly as possible,” Scott concluded.

IE