Wednesday, October 7, 2009

Regulators Want to Regulate Derivatives.. Good Luck with That

If career bankers don't understand complex financial products of their own creation (see my previous post), do you think politicians and bureaucrats understand?

Regulators seek tighter oversight of derivatives
(10/7/09 AP via Yahoo Finance)

"WASHINGTON (AP) -- As two federal regulators asked a House panel to tighten proposed legislation imposing new oversight on derivatives, Republican lawmakers contended the measure already could eliminate jobs and stifle companies' ability to manage risks.

"A potent new coalition of about 170 companies that use derivatives -- including Boeing Co., Caterpillar Inc., Ford Motor Co., General Electric Co. and Shell Oil Co. -- is lobbying Congress to make the case that legislative proposals to regulate the complex financial instruments could severely increase costs for corporate America.

""The end-user community has been constantly knocking on my door," Rep. Frank Lucas, an Oklahoma Republican, said Wednesday at a Financial Services Committee hearing.

"Companies of all kinds use derivatives to hedge against risks -- airlines ensuring against spikes in fuel prices, for example. At the same time, the complex products have become a growing vehicle for financial speculation and ballooned into a $600 trillion global trade. Regulators say they pose a threat to the stability of the financial system."

(You can read the rest of the article by clicking on the link above.)

Opponents contend that the proposed regulation would raise the cost of capital by requiring large collateral from companies that use the derivatives for their operations.

I see a problem from a slightly different angle.

What would the government regulators do when the counterparties renege on the derivative contracts, and those counterparties happen to be foreign entities? Or worse, foreign government entities? How do they enforce the regulation across the border? Do they have jurisdiction? (Short answer is No.)

Chinese government-sponsored corporations come to mind. They are threatening to default on commodity derivatives now, and they already defaulted on the forex derivatives last year (see this post from Tavakoli Structured Finance, Inc., link was from Jesse's Cafe Americain).

And their counterparties? I read somewhere long time ago that 10 biggest players in the world in derivatives trading get 90% of the business. It's not hard to guess who, and many of them are U.S. banks.

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