iOS app Android app More

Senator Says Loophole In Derivatives Regulation Undermines Reform

First Posted: 06/17/10 11:55 PM ET Updated: 05/25/11 03:45 PM ET

Cantwell

The effort to impose new restrictions on the financial system falls short of true reform if there's a gigantic loophole for foreign exchange derivatives, Sen. Maria Cantwell (D-Wash.) said Thursday.

"Most people who write about the 'comprehensive reform' -- they're missing the point, which is, you've got to have derivatives regulation," she said in an interview with the Huffington Post.

And indeed, bills being considered in Congress would bring transparency and accountability to the complex and opaque derivatives contracts that nearly brought down the financial markets last year -- by forcing them to be traded through clearing houses or on exchanges.

But the bills, based on a proposal put forth by the Obama administration, would exempt foreign exchange derivatives from disclosure requirements.

That loophole is now facing opposition in both houses of Congress.

As Cantwell explains it: "The whole foreign issue is a scapegoat. The real issue is that if you have a loophole that people can drive their tractor through, drive their volume through, you create a dark market."

This one loophole could be widely exploited, Cantwell argued, and "You can't have exemptions that are 50-80 percent of the market or it won't be reform."

Foreign exchange derivatives -- private contracts to buy or sell currencies in the future -currently make up about eight percent of the largely opaque derivatives market. U.S. firms with extensive operations overseas like Nike and Apple use them as insurance against currency fluctuations.

Virtually the entire market is traded in the shadows by the biggest banks.

Wall Street wants to keep it that way. Banks made more than $18 billion off foreign exchange derivatives in 2007 and 2008, according to a report by national bank regulator the Office of the Comptroller of the Currency. By comparison, these same banks lost about $13.7 billion during the same period from all other types of derivatives trades.

Supporters of the exemption argue that the system is working fine, and that any attempts to regulate it will simply drive the market overseas into much more opaque places, beyond the reach of meaningful regulation.

Cantwell's response to that concern: "The international community is waiting for the United States to stand up and have transparent markets before they themselves have transparent markets. Se we ought to be the beacon for how it's done, not sit around and blame foreign countries that might have dark markets."

The two leaders responsible for shepherding derivatives reform legislation through the chamber -- Financial Services Committee Chairman Barney Frank (D-Mass.) and Agriculture Committee Chairman Collin Peterson (D-Minn.) -- have committed to closing the foreign exchange loophole, the Huffington Post reported earlier this week.

In the Senate, the bill introduced by Banking Committee Chairman Christopher Dodd (D-Conn.) includes the loophole. However, since the Senate Agriculture Committee also has jurisdiction over how derivatives will be regulated (American farmers have been using derivatives for more than 100 years) it's unclear what will ultimately emerge from the Senate.

"This is a long battle," Cantwell said. "It's like a porous border. We've got to make sure we really are closing those loopholes."

FOLLOW HUFFPOST BUSINESS