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"Congress needs to fill this regulatory hole by passing legislation that would not only make credit-default swaps more transparent, but also give regulators the power to rein in fraudulent or manipulative trading practices and help everyone better assess the risks involved," Cox wrote. The SEC chairman noted that the $55 trillion credit defaults market is more than the gross national product of all the world's nations combined, and that CDSs "play an important role in the smooth functioning of capital markets." But, he said, "our markets function best when they are highly transparent," while credit default swaps have "operated in the shadows," with "no public discourse nor any legal requirement for these contracts to be reported to the Securities and Exchange Commission or any other agency." CDSs are considered to be insurance policies. They allow investors either to bet on the chance of a debt default or to protect themselves from that risk. One party pays an annual fee to another, in exchange for a promise that it will be compensated in a default. The CDS market expanded by an astounding 81% last year, and while the sector is now shrinking, it remains so large that outstanding contracts are often 10 or more times larger than the "cash" bonds they are protecting. Credit derivatives contracts are predominantly negotiated "over the counter" -- privately between traders, rather than on a central exchange. For this reason, the sector has been largely unsupervised, and that failing is coming home to roost. Cox made a number of suggestions, including that Congress should pass legislation to increase the swaps' transparency and give regulators "the power to rein in fraudulent or manipulative trading practices and help everyone better assess the risks involved." It should also require dealers to report over-the-counter swaps and their value publicly, he wrote, while the SEC "should be given explicit authority to issue rules against fraudulent, deceptive or manipulative acts and practices in credit default swaps." Congress could also provide support for federal regulators "to mandate the use of one or more central counterparties -- financially stable clearance and settlement organizations -- and exchange-like trading platforms for the credit-default swaps market." This kind of centralized clearing is currently being debated on Capitol Hill. Indeed, last week Senate Agriculture Committee Chairman Tom Harkin, D- Iowa, said he plans to introduce legislation to force over-the-counter derivatives onto exchanges and possibly even ban certain kinds of credit default swaps. Acting Commodities Futures Trading Commission Chairman Walter Lukken, testifying before the House Agriculture Committee, made similar suggestions and called for centralized clearing and for federal agencies to work together to avoid jurisdictional fights. Jurisdiction is one of the biggest and most contentious questions. Cox has asked for new regulatory powers, and Lukken wants the agencies to work in tandem. However some of Lukken's suggestions for expanding the oversight of OTC products would involve only CFTC jurisdiction, including a proposal to create a law modeled after the farm bill. That bill expanded the CFTC's powers to oversee energy swaps traded on electronic exchanges if those swaps establish a price reference for other contracts. House Agriculture Committee Chairman Collin Peterson, D-Minn., said he fears that a turf battle between the SEC, the CFTC and the Federal Reserve is starting to brew, and he worries that industry groups hoping to keep regulations to a minimum will try to exploit it. "I'm afraid the industry may try to divide and conquer here by trying to get this thing split up between three, four different groups and then avoid regulation," he said. Meanwhile, the exchanges have already taken their cue with Chicage-based CME Group, the world's largest futures exchange, likely to be first off the mark. In early October, the Chicago-based company announced it was teaming up with hedge fund Citadel to form an electronic marketplace and CCP for CDSs within 30 days. Days later, Atlanta-based InterContinental Exchange, the electronic futures exchange, struck a deal with the Clearing Corp. -- a clearing house backed by big users of credit derivatives such as Goldman, Sachs & Co., Citigroup Inc. and J.P. Morgan Chase & Co. -- to create a "global clearing solution" for CDSs. And, in Europe, Liffe, a unit of NYSE Euronext, plans to start a similar clearing project by the end of the year, ahead of Eurex, the European derivatives exchange, which is aiming to launch by the middle of next year. - Donna Block See story from The New York Times Donna Block is a senior writer for The Deal. Categories Deal Video
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Credit default swaps, the bane of Wall Street these days, should be regulated, said Securities and Exchange Commission Chairman Christopher Cox. 
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