Streetwise Professor

November 11, 2012

GiGi Wants to Rule the World. World Says Eff Off.

Go to a conference where derivatives or Frankendodd are discussed, and you can’t escape without hearing somebody’s tongue trip over the word “extraterritoriality” (say it 5 times fast!) -the imposition of Frankendodd rules (such as swap dealer registration) on foreign firms.  Gensler has been quite aggressive in his interpretation of where the CFTC’s writ extends: in his mind, it basically extends everywhere that directly or indirectly could have an impact on US markets.  In an interconnected financial world, that doesn’t limit things much.

Foreign financial institutions (and other firms, such as pension funds and money managers) are less than thrilled.  To say the least.  Some smaller institutions have announced their intention to have no dealings with US firms that could put them in the monster’s grip.

Foreign regulators have also criticized US assertions of authority, both in writing and now in GiGi’s face:

Financial regulators from around the world have rounded on the main US swaps regulator over its attempts to extend new rules on derivatives overseas, warning of destabilising effects on the global financial system.

Supervisors from Japan, Europe and Hong Kong have previously criticised the Commodity Futures Trading Commission in written correspondence. On Wednesday, the regulators set out their concerns during a public meeting at the CFTC in Washington.

GiGi nodded, and then defended the CFTC’s actions.

Regulatory arbitrage is a concern, but unilateral assertions of US authority, and foreign pushback on those assertions, raise various concerns of their own.  In particular, they threaten to balkanize derivatives markets (and financial markets generally) as non-US firms limit their dealings with US entities.  This will reduce liquidity; tend to lead to concentrations of risk; and will impede the efficient allocation of risk.

Per usual, Gensler is appealing to a simplistic version of the financial crisis to justify his position, and not acknowledging the adverse consequences-most notably due to fragmentation-that will result from over-aggressive American initiatives.  Regulatory consistency across jurisdictions (which would mitigate regulatory arbitrage) ironically is undermined by the unilateral efforts of the US regulator to impose its will around the world.

This is particularly amazing given the CFTC’s less than glorious record at regulating a subset of US derivatives markets.  Hubris, anyone?  And unfounded hubris at that?

Speaking of regulatory hubris, David at Deus ex Macchiato is justifiably outraged at the assertion by an Irish regulator that global regulations of OTC markets had “the explicit policy objective” of reducing the size of these markets.  Because of course regulators know exactly how big OTC derivative markets should be and know with metaphysical certainty that the markets will reconfigure themselves to the regulatory fiat in ways that enhance stability.  Yes, these are the most complicated, interconnected markets in the world, so of course guys in Dublin and DC should know exactly how big they should be and exactly how they should be configured.  Because that always turns out just swell.

This is exactly what Hayek meant by “the fatal conceit.”  And I fearlessly predict that this very conceit will be the source of the next crisis.

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  1. […] GiGi wants to rule the world. World says: how about […]

    Pingback by Further reading | FT Alphaville — November 12, 2012 @ 2:15 am

  2. I usually agree with much of what you and Deus Ex Macchiato write about the financial markets. But I’m surprised you find it so disagreeable that policymakers would have a specific policy objective of shrinking the OTC derivatives market.There are a couple of points I’d like to make.
    ISDA, supported by the banking community and questionable legal opinions, was able to build a gargantuan market for risk transfer products that fell outside the regulated insurance market. Unlike insurance where the insurers balance sheet is effectively owned by policyholders, ISDA and bank risk transfer products offer limited buyer protection except the old canard market participants rely on when they’re defending their market known as ‘generating market liquidity’. Many of the products have proved completely ineffective and socially useless. Moreover, the market has created significant and damaging imbalances across the financial system.
    Risk migrates across financial sectors using many different methodologies, not just those proposed by banks. As financial law converges, access to capital market liquidity is coming from many financial churches. We’re seeing morbidity, longevity, earthquake risk being transferred via capital markets. Why not credit? We’ve all heard the line of CDS as “insurance”. People are starting to understand the different types of insurance, guarantees and warrants available. It’s little understood captive insurance vehicles are essentially SPV’s. Trouble is, many financial commentators with a deep understanding of banking regulation have a more limited understanding of the regulated insurance market. Same with policymakers who have the ears of the banking community. “Just-in-time” liquidity risk management – and the absurd fallacy created by banks of “excess cash” – have undermined going concern status. The answer? More risk must be formally retained and funded.
    So, yes, the OTC Mkt of course needs shrinking; it will shrink as more corporate ‘flow’ risk is formally funded and retained as part of broader enterprise risk management strategies. We’ve seen since Hurricane Sandy how few entities have failed to pre-funded the contingent liabilities they retained; those” excesses” above which specific risks are transferred. They could rely on external liquidity in the past. Not now.
    So let’s move beyond the one dimensional debate about ISDA and look at how proper risk management agendas can be achieved using all the tools available, that is risk analytics, technology and law that can address information asymmetry. That includes the (under-performing, no doubt compared with banking over the last 30 years) insurance and reinsurance sector.

    Comment by creditplumber — November 12, 2012 @ 6:21 am

  3. How many years will it be if all of GG’s rules are enacted will we see CCP as a permanent fixture borrowing at the Fed Window?

    Comment by Jeff — November 12, 2012 @ 6:34 am

  4. Why does Gensler still have a job? I would have thought that MF Global would have been the end of any credibility for him.

    Comment by Highgamma — November 12, 2012 @ 7:11 am

  5. @Highgamma. It’s scarier than that. He is a dark horse candidate for SecTreas. Simon Johnson (I know, I know) touted him for that (along with 4 others including Sheila Bair) in Bloomberg piece yesterday. I doubt that he’ll get it (though I believe that’s been his ambition for quite a while), but he’ll most likely be reappointed Chair. Meaning that we’ll be subjected to his control freakery for the foreseeable future.

    This is an example of what I meant about camp followers and the consequences of elections in my post the other day.

    @creditplumber. I have no problem with evolutionary market processes whereby existing ways of doing business shrink or are displaced altogether. I do have a problem with regulators who think that they can manage and direct that process. That seldom works out well. And by “seldom,” I mean “never.”

    The ProfessorComment by The Professor — November 12, 2012 @ 9:29 am

  6. TSP, appreciate your response. There is plenty of plausible and rational support among financial commentators espousing the bank lobby view that the reduction in derivative and prop trading activity -and more restrictive regulation overall – will:-
    1) create further redundancies within critical wholesale financial markets that have already shown considerable remorse, taken considerable pain and now just want to move on.
    2) reduce banks ability to make deep and liquid markets thereby denying real economy participants with access to credit at fair risk premia affecting the pace of economic recovery and activity.
    3) limit the availability of risk mitigation tools for businesses.

    These arguments have a degree of plausibility but are ultimately specious.

    I also agree with your point that the regulators role is not to manage and direct evolutionary market processes. In theory, yes. In practice, however, over the last 25 years, policymakers bowed to accommodate the development of sham risk transfer mechanisms by the broader banking sector that were not built with end users at the core of the process but at the periphery. I have a greater fear that too many policymakers – thanks to the revolving door – buy into the argument that bank risk transfer tools are essential to the real economy. That is a dangerous fallacy. Better risk management can substantially address access to credit for sound businesses. The efficient allocation of capital is being prevented not by regulators but by the financial industry itself concerned that its monopolistic control over capital formation and corporate balance sheets is disappearing as fast as its ROCE. It is also being prevented by executives overpaid for operationally delivering too little but whose funding lines – and payment of fees to risk advisors and credit intermediaries – made good operational cash flow shortfalls. For all free marketeers, those are the issues that should make us all angry.

    Comment by creditplumber — November 12, 2012 @ 11:23 am

  7. […] November 13th, 2012 Treasury Secretary Gensler.  Because he did such a bang up job with MF Global. WASHINGTON, DC – DECEMBER 15: Former […]

    Pingback by Breakfast Links - Points and Figures | Points and Figures — November 13, 2012 @ 5:33 am

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