Fed’s Dudley Sees Risk Derivatives Regulators Fall Short

Federal Reserve Bank of New York President William C. Dudley said the pace of improving oversight of over-the-counter derivatives is too slow and regulators may not “go far enough” in curbing risk in the financial system.

“There are significant risks that we will fall short in this arena relative to what we are likely to achieve elsewhere,” Dudley said today in remarks in Paris.

Several nations including the U.S. are trying to align and strengthen rules for the $633 trillion market for swaps and other over-the-counter derivatives. The financial instruments became a target for tougher oversight after the 2008 collapse of Lehman Brothers Holdings Inc. and the rescue of American International Group Inc., two of the largest traders in credit-default swaps.

Plans for international cooperation include boosting the use of clearinghouses, pushing activity onto regulated markets and requiring banks to put up more collateral.

“What matters is not the standardization of OTC derivatives, central clearing or the use of the trade repositories per se, but instead the results that flow from these efforts,” Dudley said. “These institutions are just devices to achieve an end -- less risk, more robustness and greater transparency.”

Dudley, who didn’t comment on the outlook for monetary policy or the economy, said he’s concerned regulators aren’t “yet close to a harmonized, robust OTCD system” as the pace of additional oversight has been too slow.

‘More Progess’

“It seems to me that we have made much more progress in strengthening individual institutions through higher bank capital and liquidity requirements than we have made in reducing risk in the OTCD space,” Dudley said.

“Some of this is inevitable because OTCD reform is harder” and “requires the creation of new institutions to clear such trades or to house the trade information,” Dudley said.

Increased regulation of OTC derivatives should reduce the risk of funding runs and make the markets “more resilient” and less prone to being “a source of contagion in stressed environments,” he said.

The New York Fed chief said he’s concerned that trades “may not be standardized to the fullest degree possible” and that regulators should “be prepared to push harder for further standardization.” Regulators must also “push against” the “race to the bottom” of central counterparties seeking to maximize profits at the expense of compliance with best practices, he said.

Dudley called for global cooperation and “continued efforts across all stakeholders” to achieve regulators’ goals.

“Authorities must continue to coordinate their oversight of global infrastructures,” he said. One of the reasons progress is difficult is because it “requires national legislation to be flexible enough so that it can work coherently on a global basis.”

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