House Agriculture Committee Hearing - The Role of Credit Derivatives in the U.S. Economy
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REP. JIM COSTA (D-CA): Yeah. A follow-up on the gentlewoman's line of questioning as it relates to the enforcement of the SEC.
It just seems to me, as we are contemplating changing the authority and the supervision -- the oversight -- that the SEC will have, that part and parcel of that, you've got to come with recommendations to us as to what level of enforcement you're going to need. And I found your answer to the gentlewoman unsatisfactory.
Just because it's not in your division, I think that the chairman, Mr. Cox, needs to make an evaluation and they need to make a recommendation to the committee as we look at legislation. And furthermore, I would say that we need to figure out not only what you need but what it's going to cost and how we're going to pay for it.
MR. SIRRI: I'd be happy to come back to you and do that. All I meant by my answer was that having not talked to the chairman about that, I couldn't presume to offer an answer on behalf of the commission.
REP. COSTA: Earlier in your response to one of the earlier questions, I thought you commented on the fact that it was bringing into question the credibility of the financial instruments -- i.e., the derivatives. Did you not say that?
MR. SIRRI: I didn't mean to imply anything about their credibility. I believe derivatives are incredibly important.
REP. COSTA: Well, no. But I mean the viability of those instruments today.
MR. SIRRI: I'm not sure I recall the context of my remark.
REP. COSTA: Well, I mean, it seems to me with the whole question currently surrounding the issues of these derivatives, how would you describe the current health, given the current financial meltdown we're experiencing, at this point in time?
MR. SIRRI: The financial health of the derivatives markets? Well, I think it's a good question but a difficult one to answer because the derivatives markets are so varied. There are exchange- trade derivatives which have been, as far as I know, you know, going on as they have been. The over-the-counter instruments have been growing rapidly. I think we're learned through this experience that there are perhaps additional regulation that's needed. Pat went through some of the things that the President's Working Group recommended; the central counterparty is part of it.
I think my summary point would be that there is clearly an economic need that's served by the over-the-counter derivatives markets, and that's a good thing, but as they've grown, I think it's for Congress to determine, is additional oversight needed for all or parts of that market?
REP. COSTA: Well, I mean, I think there is a sense that we believe that there's greater oversight that's necessary. We're trying to grasp, as we get more understanding of how it operates, what the appropriate level of oversight is and how we protect, through transparency, you know, the financial foundations on how they interplay with the current financial mess we're in. So, I mean, in part we're playing catch-up. We're looking for not just the SEC but the other regulatory agencies to make recommendations. And it seems to me, in listening to the four of you opine as to -- on your level of oversight, it sounds to me, at best, confusing and, at worst, a total lack of ability to provide the proper regulation for this industry.
MR. SIRRI: Well, I think all I can say to that point is our authority is very circumscribed at the moment. It goes to exchange- traded instruments, and then the over-the-counter markets is only, as I've said, for anti-fraud authority. After that we have no authority. And so there are large portions of this market, of the over-the- counter derivatives markets, whether in the case of securities-based swaps for other issues that we've talked about beyond fraud, or for other kinds of commodities -- energy -- other things for which we have no authority and don't have a -- (inaudible).
REP. COSTA: Well, I think on that point that many of us feel that there is actually -- no on is in control. I mean, it's totally unregulated, it seems to me.
Mr. Dinallo, you give a state perspective on this. You talk historically about the bucket shops in the early turn of the 20th century, and you talk about trying to create some uniformity here. From a state perspective, which, from New York obviously are major players, do you think -- would you recommend in terms of from a congressional change in the way this whole regulatory framework is considered -- what's your bottom line in terms of the areas that we need to change?
MR. DINALLO: Well, having been here today and had the honor to sit through this, I would observe that it sounds like there is a lot of round pegs in sort of square holes going on in the sense that one could step back and try to rewrite it holistically. That is, CFMA left a tremendous -- dangerous and tremendous regulatory gap but still left enough jurisdiction that there is appropriate arguments going both ways.
My advice, I think from the beginning, starting this morning, was to just make sure that the committee and Congress understand what you're dealing with to the extent you're dealing with guaranteeing outcomes, which is different than a mere investment or security product. And those generally have with them higher levels of solvency and capital requirements because they're much more like, if not identical, to insurance. They have a certain amount of confidence and promise behind them that insurance companies tend to be usually very good at, and there is an entirely different approach in those situations, and you need, from a state perspective -- from a regulatory state perspective I found that, as I said earlier, very difficult to very frustrating that we didn't have any idea how much CDS was written on the companies that we were regulating, so to the extent some of them could have gone insolvent, we didn't know if that was the right or wrong decision because we didn't know what the systemic impact was going to be.
So to the extent people think about that, to the extent they also go around saying, I have insurance, when in fact we're trying to be cooperative here by stepping back and not segmenting the markets, I would make sure that there is adequate solvency, tremendous transparency, and some kind of aggregation function so you know how much risk you have at each entity.
REP. COSTA: Well, my time's expired, but one final question, if I might, Mr. Chairman. And, Mr. Dinallo, I don't know that you're the appropriate person to ask this question, but I'm not so sure the other gentlemen want to opine.
Part of the argument we get about suggesting we be cautious about how we make the changes in transparency and regulatory oversight and the ability to bring some curbs or protections, some boundaries, is that we'll lose this entire market and we'll go overseas, whether it be London or where. What's your feeling on that?
MR. DINALLO: I don't have a lot of faith, or I'm not particularly impressed with that argument after what we just went through. I think the markets will actually reward transparency on this point and the capital will come to the most transparent, efficient markets. There will be some more capital intensity on these solutions, but people will actually believe there is capital behind their counterparty transactions, which is exactly why we're in a credit freeze right now because they have no idea what the ultimate obligations and risk of cliff events are on the other side.
So I actually believe that we, to some extent, went though a time when we sort of fell in love with the European model, and the CFMA reflects this modernization going towards Solvency II and Basel II, when in fact sort of less capital-intensive, sort of capital looser models of the holding company level are not good when you're dealing with credit crisis, and that's where we're in now and I would not be swayed by that very much.
REP. COSTA: Mr. Parkinson, you look pained.
MR. PARKINSON: No, I'm not pained. I would add a different point. I think if we -- we have to be conscious that this is a global market, and indeed the majority of the activity is conducted not in the United States but in London. But that's not an argument if we see a need for change to achieve specific policy objectives, as in the case of various theories that have been outlined in a PWG statement that we be -- we hesitate to do that for fear of the activity going offshore. Rather, it suggests we should be coordinating and cooperating with the foreign authorities, and in fact that's what we have done, at least with respect to the infrastructure issues.
And I think going forward, on the broad range of issues, we work through something called the Financial Stability Forum, which includes representatives of all the major jurisdictions, including London, which is the other important jurisdiction in terms of CDS activity.
REP. COSTA: Well, the chairman's taking the committee over there in a week or so, so I guess we'll get a better understanding as to the level of collaboration that they believe is taking place.
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