Greenspan urges expemption for derivatives

Associated Press | February 11, 2000

WASHINGTON (AP) -- Federal Reserve Chairman Alan Greenspan urged Congress on Thursday to act quickly to exempt from regulation the $80 trillion market in so-called over-the-counter derivatives, saying legal uncertainty is posing "unacceptable risks to the country's financial system."

Derivatives are complex financial instruments whose value depends on the value or change in value of an underlying security, commodity or asset. They are used by businesses to guard against losses from unexpected market movements, but also by high-risk investment funds to speculate. Derivatives played a key role in the near-collapse in September 1998 of hedge fund Long-Term Capital Management, which sent shock waves through world financial markets. Over-the-counter derivatives are traded privately between investors, as opposed to those derivatives traded on futures exchanges.

Greenspan, testifying before the Senate Agriculture Committee, asked lawmakers to adopt the recommendations of a White House task force, which included exempting over-the-counter derivatives from government regulation and allowing the financial institutions using them to police the market themselves.

Joining Greenspan in his request were Treasury Secretary Lawrence Summers and William Rainer, chairman of the Commodity Futures Trading Commission. Like Greenspan, they are members of the President's Working Group on Financial Markets, which was established after the October 1987 stock market crash.

"I see a real risk that, if we fail to rationalize our regulation of centralized trading mechanisms for financial instruments, these markets and the related profits and employment opportunities will be lost to foreign jurisdictions that maintain the confidence of global investors without imposing so many regulatory constraints," Greenspan said. The legal uncertainty hanging over the off-exchange derivatives market could "move a very substantial part of this market overseas" where regulations are looser or don't exist, he warned.

Doubt was cast on the legal status of the financial instruments in 1998 when the futures trading commission suggested it had the right to regulate trading in them.

Sen. Richard Lugar, R-Ind., the Agriculture Committee's chairman, said one of his goals "is to provide legal and regulatory certainty to the over-the-counter (derivatives) market."