The US comptroller of the currency warns of overreaction in making rules for derivatives.
The risk attributed to derivatives is often far greater than the reality. So said Acting Comptroller of the Currency (OCC) John Walsh in a speech on Tuesday. Regulators need to keep this in mind as they write the rules, making sure they conform to the lower risk reality rather than the hyperbolic numbers that are thrown about.
“Lack of understanding feeds misperception, and derivatives are not particularly well understood, even by some top policymakers,” Mr. Walsh said in speech before the American Securitization Forum. “This is not just a matter of the risks involved, but extends even to the size of the market.”
According to the OCC’s most recent quarterly report on bank trading and derivatives activities, the notional value of derivatives contracts was $248tn at the end of September. And that notional value “is a number that is frequently cited in somber terms to describe the size—and risk—of the market,” Mr. Walsh said. “But of course that’s far from the mark…the risk ascribed to derivatives is often many orders of magnitude greater than the reality.” Certainly, derivatives played a role in the financial crisis, Mr. Walsh said. “In the popular retelling of the financial crisis, derivatives played a crucial role in both hiding and amplifying risk…But, the critique of derivatives that has emerged is far broader than the specific instruments or circumstances implicated in the crisis.”
Mr. Walsh’s observations should be welcome to corporate treasurers hungry for level-headed thinking when it comes to regulating derivatives. The CFTC, which is the primary regulatory authority over all swaps, including energy and agricultural swaps, the SEC, which has authority over “security-based swaps,” and the Fed currently are in the throes of writing and implementing rules for derivatives (after lots of delays). The problem is despite promised exemptions to certain end-users, it’s never a sure thing; and a volatile political environment given to quick shifts in sentiment makes it harder to understand and plan.
And even with exemptions, companies are struggling with the prospect of increasing headcount just to comply with rules, as well as the new cost that banks will incur in their compliance – costs that will most likely passed on to corporations.
“As we write regulations to address the excessive risk taking and failures of risk management that helped bring on the financial crisis, we must take care to avoid making it more difficult for banks to manage their own risks and to serve the legitimate needs of their customers,” Mr. Walsh said in his speech. Treasurers meanwhile will keep their fingers crossed that the OCC’s regulatory cousins are listening.