Michael Giberson
The title is lifted directly out of Craig Pirrong’s post on the Treasury departments proposal to “crack down on off-exchange trading of exotic financial instruments blamed for sparking last year’s crisis” (in the words of yesterday’s WSJ article).
The Treasury wants derivatives contracts that commonly trade over-the-counter to trade through a centralized clearinghouse offering a common counterparty. Not all derivatives contracts are standardized enough to trade over-the-counter, and the Treasury proposes to not subject customized derivatives to the clearinghouse requirement. That raises the issue of how you prevent interested parties from customizing their otherwise standard contracts “just enough” to avoid the requirement. Treasury proposes to make clearinghouses responsible for ensuring customization doesn’t allow parties to skirt the clearinghouse requirement.
On this last issue Pirrong said, “It suggests a serious failure to think things through” on the part of the Treasury.
More to the point, Pirrong observes:
If they decide to prevent the use of customization to circumvent the clearing requirement, as it almost certainly must if the clearing mandate is to survive, Treasury and Congress will require a regulator to enforce the circumvention ban. This would require an incredibly intrusive regulator, evaluating the design of every contract, and the intent behind it. I can state almost categorically that no regulator has or will have the information, expertise, or ESP required to do this. Moreover, this will just throw us back into the days of pre-CFMA requirement that all “futures” be traded on exchanges. Not a good thing. This created regulatory uncertainty, legal ambiguity, and served to protect the interests of exchanges. One can only imagine the Talmudic inquiries that would be involved in determining whether a particular derivative is, or should be cleared, or was designed to escape a clearing mandate.
Exactly so.
They will just go off-shore.
We don’t need an FDA approval system to get an improvement.
You could increase the demand for exchange trading of derivatives by requiring the total potential loss of a non-exchange traded derivatives to be collateralized when the trade is created would allow all sorts of derivatives to exist while providing an inventive to move derivatives to exchanges. If that is too draconian, make the requirement 75% collateralized or something like that.
You could increase the supply by providing an exemption to anti-trust laws for dealers getting together in creating exchanges as long as they allowed others to buy in later at a some price.
It will be hard for regulated utilities to go offshore, but the option may become attractive for some parts of the domestic energy business.