AFR Urges Congress to Regulate the Derivatives Markets

congress08Americans for Financial Reform (“AFR”) is a coalition of nearly 200 national, state and local consumer, employee, investor, community and civil rights organizations who seek meaningful reform of our banking and financial system. A list of the AFR coalition members is attached.

AFR writes to urge Congress to enact comprehensive reform of over-the-counter (OTC) derivatives markets.  In particular, we support all efforts to require derivatives trading to be conducted on fully regulated and publicly transparent exchanges that ensure capital adequacy and tough prohibitions against fraud, manipulation, and excessive speculation.  We also support all efforts that will subject all marketers of derivatives instruments to registration, business conduct rules, complete record keeping, and strict capital adequacy requirements.

There are few issues before Congress that so directly impact the American public. Recent history has demonstrated, painfully and unequivocally, that the multi-trillion dollar unregulated OTC derivative market has produced devastating consequences for businesses, workers, homeowners, consumers, and, consequently, the entire economy.[1]

We know now, for example, that the unregulated multi-trillion dollar OTC credit default swaps market fomented a mortgage crisis, then a credit crisis, and finally a “once-in-a-century” financial crisis that, but for trillion dollar U.S. taxpayer interventions, would have completely destroyed our financial system.[2] It is also now widely acknowledged that speculators in unregulated OTC energy derivatives accounted for the dizzying volatility of crude oil during the last 18 months: with no underlying change in supply and demand, oil oscillated from $68 per barrel in

January 2008 to $145 in June to $33 in December to $72 in June 2009.[3] Consumers and businesses—and consequently, the entire American economy—suffer tremendously under this volatility.

In response to the catastrophic consequences of unregulated derivatives, the Obama Administration has proposed that all standardized OTC derivatives be subject to exchange trading and be overseen in accordance to the traditional dictates of market regulation in place since the New Deal and abandoned only in the deregulation of OTC derivative markets in 2000.  Those principles are: (1) full transparency; (2) capital adequacy; and (3) prohibitions against fraud and manipulation.  The Administration has also recommended that “[a]ll OTC derivatives dealers and all other firms whose activities in those markets create large exposures to counterparties should be subject to a robust and appropriate regime of prudential supervision and regulation,”[4] including the imposition of increased capital requirements, business conduct standards, and auditing requirements.[5]

The Administration has also provided that so-called “customized” derivatives may remain traded as over-the-counter derivatives. The Administration acknowledges the potential for exploitation that differentiated derivative regulation entails, and seeks to close any perceived “customization” loophole through greater oversight over dealers in customized products.  Treasury Secretary Geithner has said that as yet unannounced criteria for distinguishing customized from standardized derivatives will be, by design, “difficult to evade.”[6] CFTC Chairman Gary Gensler has articulated a series of tests that would delineate standardized from customized instruments in a manner that would create a strong presumption that most of the existing OTC market would be deemed standardized and thus subject to exchange trading.[7]

In addition to the Administration’s proposals, several on Capitol Hill have made vital contributions to the debate on OTC derivative reform.  Senator Tom Harkin has drafted legislation that would require all derivatives to be exchange-traded.[8] Chairman Barney Frank of the House Financial Services Committee and Chairman Collin Peterson of the House Agriculture Committee have also recently announced a legislative outline for derivatives reform “that generally mirror[s] a broad proposal from the Obama Administration to increase regulation of derivatives, by forcing many of them onto standardized exchanges [while] increasing capital requirements for contracts that can’t be traded on exchanges.”[9]

We applaud the Obama Administration, and Chairmen Harkin, Frank and Peterson, for their sound proposals in this vital area.  AFR strongly supports a regulatory approach requiring that virtually all derivatives be traded on well capitalized exchanges.[10] That kind of law would return derivatives trading to the regulatory framework in place for decades before the Commodity Futures Modernization Act of 2000 sanctioned the vast deregulated and destabilizing OTC market.  As was the case under that earlier regulatory framework, businesses’ commercial needs for legitimate hedging can be safely met through derivatives traded through publicly transparent and well capitalized exchanges with rare, individually negotiated off-exchange exceptions approved by the federal regulator for legitimate, tailored business needs and supported by enhanced capital adequacy requirements.  We also support the imposition of broad and conservative capital, collateral, reporting and business conduct standards on all marketers of derivative products.

Other proposals have acknowledged the need for broad regulatory oversight of OTC derivatives, but would create a new office within the Treasury Department with veto power over the regulatory and enforcement efforts of the CFTC and SEC.[11] We disagree with such a cumbersome two-tiered regulatory structure.  The CFTC and SEC have superior enforcement expertise and more intimate interactions with the relevant markets than does the Treasury.  As Chairman Gensler has said, the SEC and CFTC must have “clear, unimpeded authority” to regulate effectively derivatives markets.[12]

In the wake of the worst financial crisis since the Great Depression,  there is no justification to continue private, opaque and highly risky financial transactions that expose the nation’s economy to systemic break-downs that jeopardize jobs and homes while, at the same time, burdening taxpayers with the unsustainable role of financial savior of last resort. We therefore urge you to adopt sound, meaningful, and, most importantly, fully comprehensive regulation of the OTC derivatives markets.


Americans for Financial Reform

Americans for Financial Reform’s Executive Committee

Steve Arbecht, Service Employees International Union

Rob Johnson, Roosevelt Institution (for identification purposes only)

Nancy Zirkin, Leadership Conference on Civil Rights

Gary Kalman, U.S. Public Interest Research Group

Heather Booth, Americans for Financial Reform


A New Way Forward

Consumer Federation of America

Consumers Union

Consumer Watchdog

International Brotherhood of Teamsters

Community Reinvestment Association of North Carolina

Public Citizen

Roosevelt Institute

Sargent Shriver Center on Poverty Law

Service Employees International Union

United Food and Commercial Workers


U.S. Public Interest Research Group

[1] Vikas Bajaj, Surprises in a Closer Look at Credit-Default Swaps, N.Y. Times, November 4, 2008; Jon Hilsenrath, Worst Crisis Since ’30s, With No End In Sight, Wall St. J. September 18, 2008.

[2] Testimony of Alan Greenspan, Committee of Government Oversight and Reform, October 23, 2008.

[3] Organization of Petroleum Exporting Countries, World Oil Outlook 2009, available at:  Gordon Brown and Nicolas Sarkozy, We Must Address Oil-Market Volatility, Wall St. J., July 8, 2009.    International Monetary Fund, Regional Economic Outlook: Middle East and Central Asia, May 2008, 27-28.  Ianthe Jeanne Dugan and Alistair Macdonald, Traders Blamed for Oil Spike, Wall St. J., July 28, 2009 (highlighting the CFTC’s official position that speculators accounted for the volatility in oil futures). Prices as quoted on the New York Mercantile Exchange.

[4] Administration’s White Paper, Financial Regulatory Reform: A New Foundation, page 48, available at (emphasis added).

[5] Id. at 6-7

[6] Timothy F. Geithner, Testimony Before House Financial Services and Agriculture Committees,

Joint Hearing on Regulation of OTC Derivatives 5, July 10, 2009, available at

[7] Gensler, Transcript, Hearing of the Senate Committee on Agriculture, Nutrition and Forestry; Regulatory Reform and the Derivatives Markets; June 4, 2009.

[8] Derivatives Trading Integrity Act of 2009, S. 272, 111th Cong. (2009).  See also Sarah N. Lynch, Harkin Seeks to Force All Derivatives Onto Exchanges, Wall St. J., November 20, 2008

[9] Reuters, Rep Peterson Says Us House Bill May Ban Naked CDS, July 21, 2009, available at

[10] Derivatives Trading Integrity Act of 2009, S. 272, 111th Cong. (2009)

[11] Dawn Kopecki and Shannon D. Harrington, Treasury Would Oversee Derivatives Under Alternative House Bill,, July 22, 2009, available at

[12] Testimony of Chairman Gary Gensler, CFTC, Before the Subcommittee on Securities, Insurance, and Investment, Committee on Banking, Housing and Urban Affairs, United States Senate, June 22, 2009,