There's a general consensus that Sen. Blanche Lincoln's derivatives bill, which passed her Agriculture Committee yesterday, is pretty strong,and I generally agree. But there have been critics who point to loopholes -- let's investigate one!One interesting question revolves around exchange trading, mentioned here, which would increase the transparency of the derivatives market and provide an easy venue for a central clearing process.
Lincoln's bill does a good job making sure that almost all derivatives go through a central clearinghouse -- looks like this, and is good because of this -- in order to make sure that these instruments are properly capitalized and used safely. But exchange trading, which puts these derivatives on a transparent marketplace (sort of like the New York Stock Exchange, or perhaps in a better example, the Chicago Mercantile Exchange), would make the market even more transparent.
Lincoln's bill mandates that all cleared derivatives be traded on exchanges ... or in "swap execution facilities," which are basically private exchanges set up by the banks. That's how derivatives are often traded now, in what are called "dark pools." True, the Lincoln bill mandates that these internal facilities post their price and trading data, but only after the fact. There is no requirement for pre-trade transparency. Now, this is better than the status quo, but it still seems somewhat problematic.
There's also an exception from exchange trading for products that exchanges won't trade. (Recursive, no?) It seems like that's designed to deal with new financial products that make up a tiny part of the market, but it also seems to offer another way to go around the bill's intent.
Now, whether these exceptions become pernicious depends on how regulators use their authority. Gary Gensler and Mary Schapiro are the two most direct derivatives market supervisors, and I think they'll do a fairly decent job with implementation. But I'm still concerned that these rules aren't drawn as tightly as they ought to be, and this bill is going to be passed faster rather than slower.
-- Tim Fernholz
