Tuesday, October 20, 2009

Beware Of New Regulation Of Derivatives By Rep. Eric Cantor

Source: http://www.investors.com/NewsAndAnalysis/Article.aspx?id=509198


In the face of public outcry over the nation's financial crisis, a tried-and-true tradition of finger-pointing is under way in Washington.

Instead of taking a measured approach to identifying the root causes of our financial collapse, many in Washington are focusing on an easy villain that many Americans don't appreciate: the derivatives market.

This sentiment drove the House Financial Services Committee on Wednesday to pass new rules that could have far-reaching constraints on derivatives and may irreparably harm American businesses and consumers in the future.

Rather than the tool for gross financial manipulation it is portrayed to be, the derivatives market plays a very important role in solidifying the competitiveness of American businesses.

Derivatives enable businesses and investors of all sorts, especially nonfinancial corporations, to hedge risk efficiently. The benefits of successful risk management include greater confidence and predictability in the underlying business, which leads to more jobs and ultimately trickles down to consumers in the form of lower prices.

To be sure, Republicans believe that more transparency in the financial markets is always better. A system that requires companies to report their derivatives trades to a regulator monitoring risk makes more sense as long as that information is protected from competitors who could benefit unfairly if all hedging information were forced to be openly disclosed.

We also agree that the growth of listed and centrally cleared derivatives is a positive step that should be encouraged.

Yet there's a fine line between enforcing smart regulations designed to keep innovative markets functioning and erecting hurdles that restrict American companies' ability to compete on the global stage.

House Republicans fear that line is now being blurred. By granting government regulators the power to impose on an ad hoc basis stiff collateral and margin requirements, legislation passed Wednesday in the House Financial Services Committee could spell disaster for the over-the-counter derivatives market.

While today many hedgers are able to enter into OTC derivative contracts with willing counterparties based on their credit rating, the new regulations will force companies to choose between two difficult options: Use up their precious working capital to satisfy unnecessarily burdensome requirements or utilize exchange-listed derivatives that likely provide an imperfect hedge to the underlying risk.

Neither of these choices is attractive. The first means capital that should be helping companies grow, invest and create jobs now has to be diverted to manage risk.

The latter option leaves companies without customized options to manage their risk; they thus have to compensate by, for instance, charging higher prices. It also introduces a new "basis risk," which is the potential for the movement in price between the risk the company is attempting to hedge and the actual risk that the listed or centrally cleared product hedges.

Once again, the result is the need to compensate by investing less elsewhere or raising prices.

As we see, rushed government action can have unintended consequences that can hurt job growth and set our businesses on a weaker competitive footing. Congress should give thoughtful consideration to these ramifications before the bill comes before the full House in the coming weeks.

• Cantor is the House Republican Whip.

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