U.S. Urges Against Derivatives Regulation

WASHINGTON —  U.S. regulators said Tuesday that the rich investors and institutions that trade complex financial contracts known as derivatives don’t need new government oversight.

Four agencies, after a year of study that stemmed from the $4 billion in losses from derivatives and other investments at hedge fund Long-Term Capital Management--losses that nearly sank the fund--issued a report urging Congress to keep the government’s hands out of derivatives regulation.

Congress asked the heads of the Treasury Department, the Securities and Exchange Commission, the Federal Reserve Board and the Commodity Futures Trading Commission to recommend what role the government should play in the mostly unregulated world of over-the-counter derivatives--contracts that essentially allow companies and financial institutions to speculate with each other, or to hedge market bets.

They’re called derivatives because a contract’s value is derived from changes in an underlying asset’s value over a set period. Derivatives based on assets worth an estimated $80 trillion are held by institutions worldwide, though only a fraction of that represents actual money at risk.

Regulators’ rationale in advising against more oversight was that most such derivative transactions are between large institutions that know what they’re doing.

Although such OTC derivatives are largely unregulated, the Commodity Exchange Act, the main law governing formal futures and commodities trading, doesn’t make that unregulated status crystal clear.

The regulators recommended that Congress specifically exclude from the law financial derivatives deals entered into by qualified parties.

The suggestions “would remove legal uncertainty,” said Lee Sachs, Treasury’s assistant secretary for markets. And that should lead to more competition and innovation in the derivatives market, he said.

But the report met with disdain from organized futures and options exchanges, which view OTC derivatives as unfair competition.

“Any attempts at serious regulatory reform should be fair and evenhanded for OTC and exchange markets, and the working group’s report falls far short of meeting that standard,” the Chicago Board of Trade, the Chicago Mercantile Exchange and the New York Mercantile Exchange said.

The regulators also advised Congress to formally authorize existing “clearinghouses” to clear derivatives transactions, as long as the companies are overseen by one of the major regulators.

That would improve the ability of the major clearinghouses (such as brokerages) and regulators to keep track of any buildup of derivative-contract risk at a single institution--such as Long-Term Capital.

Regulators did suggest one new regulatory step: a crackdown on offshore firms that hype currency futures to individual investors.