We admit it. We like headlines like this one ? It’s Time for Sensible Regulation of Derivatives – which we first came across on The Exchange, a Yahoo! Finance blog.
But as it’s a blog (like media.comment), we weren’t too excited – until we saw that one of the authors was Martin Neil Baily, former chairman of the US Council of Economic Advisors. Dr. Baily (who served in the Clinton Administration) and his co-authors (who served in the Obama Administration) support derivatives activities:
“The bulk of derivatives are interest rate swaps, credit default swaps on corporate bonds and municipal and state bonds, commodity price derivatives, and currency swaps. These markets did not break down in the crisis and did not contribute to it.”
The authors also support prudent derivatives regulation, and “want to get that regulation right.” They are concerned, though, about some aspects of regulatory reform.
“It is worth asking if the myriad of rules put into place in Dodd-Frank to regulate derivatives can work together effectively and coherently. Congress, and the Financial Stability Oversight Council, should ensure that the different regulatory bodies work together to craft consistent rules of the game. Tackle the problems that emerged in the derivatives market and improve the economy’s stability, while still reaping the economic benefits derivatives can and do provide.”
It stands to reason: to develop effective derivatives regulation, we need to accurately understand the problems we are trying to solve. What are those problems? As Dr. Baily noted last month in a Brookings Institution conference on the purposes, structure and regulation of the financial industry:
“I think derivatives maybe have been…overstated a bit in their influence on the crisis. Like many historical crises…the one we’ve been going through I think was fundamentally caused because financial institutions bought and held bad assets…”
He went on to note:
“…I don’t think derivatives are the main story and I think all derivatives should not necessarily be viewed as toxic as Buffett said…”
One of the major issues related to derivatives in the financial crisis, he said, was “We didn’t know enough about the derivatives that were out there, who was holding them, what the implications would be…there was a real lack of information.” This concern helped give rise to the establishment of trade repositories to which market participants report their transactions, providing regulators more and better and deeper transparency on exposures and activities than ever before. (The need for regulatory transparency is why we oppose fragmentation of trade reporting and repositories, as outlined in our recent letter.)
The other major issue noted by Dr. Baily was AIG’s credit default swaps. As we have written elsewhere, the AIG situation reflected a failure to adequately measure and manage liquidity and collateral requirements. Had a robust variation margin framework been in place, AIG’s bail-out likely would have been averted.
Sensible indeed.
Latest
ISDA AGM Studio: Antonio Corbi and Fabio Fabiani, EY
Fabio Fabiani, partner at EY, speaks with Antonio Corbi, head of accounting and tax services at ISDA, on the International Accounting Standards Board’s dynamic risk management proposal and the application of the Common Domain Model to automate reporting and compliance.
ISDA AGM Studio: Sarah Breeden, Bank of England
Sarah Breeden, deputy governor for financial stability at the Bank of England, speaks to ISDA CEO Scott O’Malia about some of the headwinds facing financial markets in 2025, and how policymakers can address perceived vulnerabilities in non-bank financial intermediation.
ISDA AGM Studio: Tom Jasper and Eric Litvack
ISDA's 40th anniversary was a key theme of this year's Annual General Meeting. To mark this milestone, Nick Sawyer, ISDA's global head of communications, talked to Tom Jasper, managing partner at Manursing Partners, who established and led the interest rate...
ISDA AGM Studio: Roy Choudhury and Ido de Geus
Roy Choudhury, managing director and senior partner at Boston Consulting Group, and Ido de Geus, head of fixed income at PGGM Investments, talk to Nick Sawyer, ISDA’s global head of communications, about the uses and value of over-the-counter derivatives.