Today the bill that I had reported on earlier regulating the CDS marketplace has apparently morphed a bit and may be reported tomorrow:
WASHINGTON, Feb 11 (Reuters) - The U.S. futures industry regulator would be empowered under a bill filed by the House Agriculture Committee chairman on Wednesday to suspend trading in credit default swaps if needed to protect investors and the financial market.
The bill also would require clearing of over-the-counter transactions through entities registered with the Commodity Futures Trading Commission or the Securities and Exchange Commission, according to a summary.
It said banks could clear OTC transactions if they registered with CFTC as a derivatives clearing organization or with the SEC as a clearing agency. The Federal Reserve would be barred from regulating clearing houses.
CFTC would gain criminal prosecutorial power under the bill, which is scheduled for committee discussion and vote on Thursday afternoon.
I'd say "that's a good start".
I've got a few problems with the bill, chief among them the lack of public disclosure for those firms that exercise the exemption for OTC transactions.
A huge part of the so-called "attraction" for firms to trade these things is their opacity in the marketplace; that is, I cannot obtain an accurate, multi-seller (or buyer) set of quotes on bid and offer without making a shedload of individuals calls and other inquiries. Contrast this with the market for stocks, options and futures contracts where I can see market depth instantly on my computer screen for bid, offer and size in each.
The opacity makes it extremely lucrative for the banks that trade these things, but that "lucrative" factor is in fact on the back of their customers, who get screwed repeatedly - they overpay as a consequence of the lack of published market action.
This problem extends to all sorts of swaps, not just "single name CDS" that people are all cranked up about (e.g. CDS on Goldman); in fact, some of the worst abuses appears to have been among the banks that wrote interest-rate swaps to municipalities - generally-unsophisticated clients who employed "trust me" on pricing and as a consequence got raped raw. There have even been allegations of criminal misconduct (e.g. bribery, etc) in some of these "deals" of late.
Secrecy dramatically worsens the deal for those who do not control the transaction in every case and the customer is definitely not the one in control. Ergo, I believe that these contracts must all be forced onto an exchange where bid/offer/OI/etc is available to the public just as it is for stocks, options and futures contracts.
I further would argue that writing CDS on a firm that has an explicit government backstop or guarantee is an inherently ridiculous circumstance that should be barred outright; if you really want to short the United States, then buy a CDS on Treasuries!
Finally, I would argue that the original draft which prohibited writing "naked" CDS outright was headed in the right direction; we already have speculative instruments in the market and they serve a necessary function, but speculative instruments + opacity + insider control of pricing = fraud writ large, and I believe we've seen plenty of it over the last year and a half with no small part of it emanating from this corner of the so-called "market".
Nonetheless this bill is a good start and certainly beats where we are now.
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