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September 20, 2011

Geithner Pushes for International Rules to Govern Derivatives Market

CQTreasury Secretary on Monday urged international regulators to follow the United States’ lead and toughen oversight of financial derivatives.

“Just as we have global minimum standards for bank capital — expressed in a tangible international agreement — we need global minimum standards for margins on uncleared derivatives trades,” Geithner said in prepared remarks at the International Monetary Conference in Atlanta. “A global approach to margin will help prevent regulatory arbitrage and a ‘race to the bottom.’ “

Geithner’s push comes as some lawmakers worry U.S. regulators will move forward on tough new rules without international buy-in, which could leave American firms at a disadvantage.

Last month, nearly the entire New York congressional delegation, led by Democratic Sen. Charles E. Schumer, wrote a letter to regulators urging them to reconsider a proposed regulation setting new margin requirements for certain derivatives trades between subsidiaries of U.S. financial institutions abroad and non-U.S. parties.

While the new rules are not finalized, they could require U.S. firms to put up more money than foreign-based companies to guarantee their derivative trades. Companies and financial institutions often use derivatives to hedge risks associated with business operations, such as fluctuations in interest rates or gas prices.

The lawmakers said they were worried the proposed rule would encourage foreign companies to avoid doing business with overseas affiliates of U.S. financial institutions; they urged regulators to hold off on the rule and work with their counterparts abroad to ensure equally stringent rules are adopted in other countries.

“Rewriting the regulatory framework for derivatives trading in the U.S. is an important step in making our financial system more resilient and more transparent,” wrote the New York lawmakers. “But absent harmonization between new rules here and abroad, disparate treatment of U.S. firms will only encourage participants in the derivatives markets to do business with non-U.S. firms.”

In their letter, the lawmakers also echoed Geithner’s concerns with “regulatory arbitrage” and a potential “race to the bottom,” but they went further in calling for regulators to hold off on finalizing the rule until international regulators were prepared to impose similar restrictions.

‘Leadership Role’

In his speech, Geithner urged other countries to take steps similar to the U.S. measures. “The United States has taken an important leadership role in comprehensive reform of the over-the-counter derivatives market,” he said. “Alignment with Europe and Asia is essential.”

Last year’s financial regulatory overhaul (PL 111-203) provided the authority to regulate the over-the-counter derivatives market for the first time. But the New York lawmakers said the proposed rule goes beyond the intent of the law by imposing a regulation that would harm the competitiveness of U.S. financial institutions more than it would protect the safety of the broader financial system.

“The issue that the New Yorkers have raised is legitimate, namely that we are talking about transactions that are entirely offshore,” said Rep. Barney Frank, D-Mass., an architect of the law. Frank said regulators “may not have looked at the implications,” adding, “I hope they’ll fix that.”

A Democratic aide working on the issue said regulators are aware of the financial industry’s concerns. “I’m optimistic that they will figure out a way, on the one hand, to address the competitive concern, and on the other, [to make sure] there isn’t a way to evade the . . . regulations just by doing it overseas,” said the aide, who was not authorized to speak publicly. “I think they can do that.”

Barbara Hagenbaugh, a Federal Reserve spokeswoman, declined to comment on the issue, other than to point to what was put out in the proposed rule. The Fed is writing the new rules along with several U.S. regulatory agencies, including the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC).

GOP Pushes Broader Delay

House Republicans have seized on the Democratic lawmakers’ concerns as reason to delay the broader regulation of derivatives under last year’s law. On May 24, the House Financial Services Committee approved a bill (HR 1573) that would delay the regulation of derivatives for 18 months.

“Our colleagues from New York are exactly right,” said the panel’s chairman, Spencer Bachus, R-Ala., at the markup. “If we create a prohibitively expensive and rigid climate for the use and trading of derivatives in the United States, the market could very well shift overseas, and once markets leave they will not return.”

Frank and other Democrats countered that GOP lawmakers simply wanted to strip regulators of their new powers, and that changes to the law were not necessary for regulators to modify their proposed rule. The bill was approved on a party-line vote, 30-24.

Geithner used the speech as an opportunity to blast “the effort by politicians and groups that oppose financial reform to starve the regulatory agencies of the resources they need to carry out their new responsibilities” and the use of the confirmation process to block important regulatory agency appointments.

House Republicans have been pushing spending cuts to the CFTC and the SEC, which are tasked with broad new authority to regulate derivatives in addition to their existing responsibilities.

In the Senate, Republicans have refused to confirm nominees to key financial posts. Peter A. Diamond, the Nobel Prize-winning economist whom Obama picked to serve on the Federal Reserve Board, announced Monday that he was withdrawing his nomination in the face of GOP opposition.

Republican senators have also pledged to block any nominee to direct the new Consumer Financial Protection Bureau absent substantial changes that would weaken its authority.

Dennis Kelleher, president and CEO of the public interest group Better Markets, applauded Geithner’s address.

“It is shortsighted and corrosive for countries competing to attract business by offering the lowest regulation possible,” he said. “That is why the U.S. must set high, clear and strong standards for derivatives, capital, transparency and financial regulation across the board.”

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