Copyright 2002 The Washington Post  

The Washington Post
February 22, 2002, Friday, Final Edition
SECTION: FINANCIAL; Pg. E01

LENGTH: 971 words

HEADLINE: Who's Minding Derivatives?; After Enron, the Debate Over Regulation Gets Sharper

BYLINE: Kathleen Day, Washington Post Staff Writer

BODY:
It's a market that's fast growing, worth trillions of dollars and credited with keeping the economy rolling. It's also a tangle of largely unregulated financial contracts that have played a role in at least five major financial scandals in the last eight years, including that of Enron Corp.

Could the current hand-wringing in Congress finally prompt oversight of this extremely valuable, highly volatile web of financial agreements known as the over-the-counter derivatives market?

Thomas J. Erickson, commissioner of the Commodity Futures Trading Commission, says he's not overly optimistic. Since being appointed commissioner in June 1999 by then-President Clinton, Erickson's has been one of the few voices in Washington calling for greater federal oversight of these derivatives.

Even as Congress holds dozens of hearings into Enron's collapse, Erickson points out it was Congress that just over a year ago passed legislation allowing energy contracts like those at the heart of Enron's business to be traded with no government oversight.

He opposed that aspect of the December 2000 legislation, despite its support from Federal Reserve Board Chairman Alan Greenspan and a fellow Clinton appointee, then-CFTC Chairman William J. Rainer. Erickson continues to oppose it, a stance that puts him at odds with the current CFTC chairman, Bush appointee James E. Newsome.

"In the Wake of Enron, I believe that it is more important than ever for the Commodity Futures Trading Commission to inform Congress of the potential risks associated with the unregulated trading of derivatives," he wrote to the Senate Energy and Natural Resources Committee recently to underscore he didn't agree with Newsome's testimony before the panel at the end of January.

"We have an affirmative duty to reexamine the rationale behind Enron operating a financial marketplace without direct oversight by any federal financial regulator," he said. "Consumers are the ultimate victims when markets are manipulated, or otherwise affected by unlawful behavior."

OTC derivatives are financial contracts that are not traded on a formal exchange such as the New York Mercantile Exchange. Like regulated derivatives, the worth of unregulated contracts is based on the value of underlying stocks or bonds, interest rates, currencies or other commodities. The financial world uses these contracts to hedge against the risk of price fluctuations or to speculate. Enron also used them to inflate its balance sheet and hide debt.

OTC derivatives have grown sevenfold during the past decade and are now a key risk-management tool for nearly every business, from automakers wanting to pin down future borrowing costs to banks wanting to minimize losses from interest-rate changes.

Erickson said that because these contracts play such a pivotal role in the finances of most publicly traded companies, they require the transparency, disclosure and reporting demanded of other financial instruments.

Those who oppose regulation of the over-the-counter derivatives market say it shows no signs of needing oversight. Although no regulator directly monitors the actual trading of over-the-counter derivatives, federal bank regulators oversee banks that deal in over-the-counter derivatives, and the Securities and Exchange Commission oversees securities firms that trade them.

It's only a small handful of large traders -- Enron Online and GE Capital, for example -- that are completely unregulated because they are not affiliated with a bank or securities firm.

These dealers "constitute a small share of the overall market, although the extent of their participation in certain markets, such as the market for energy derivatives, is quite significant," the President's Working Group on Financial Markets wrote in a report on derivatives in November 1999.

The report -- signed by Greenspan, Rainer, then-SEC Chairman Arthur Levitt, and then-Treasury Secretary Lawrence Summers, who were the members of the working group -- recommended that these companies be allowed to continue to operate without oversight, but added that "continued monitoring of their activity is appropriate."

Erickson is a 40-year-old lawyer and South Dakota native who came to Washington in 1987 to work for Sen. Thomas A. Daschle (D-S.D.). He then worked for seven years for an association of derivatives traders and regulated derivative exchanges known as the National Grain Trade Council, leaving in 1997 for the CFTC to be its chief lobbyist under then-CFTC Chairman Brooksley Born.

Born, an advocate of greater derivatives oversight, was constantly at odds with the industry, as well as Greenspan and then-Treasury Secretary Robert Rubin. In mid-1999, Born was replaced by Rainer. Rainer helped negotiate legislation passed in 2000 that removed what little CFTC oversight there had been on over-the-counter energy derivatives.

Now Sen. Dianne Feinstein (D-Calif.) has introduced legislation to revoke the provision of the 2000 law affecting energy derivatives, although it is unclear how much chance it has of passing.

Rep. Peter A. DeFazio (D-Ore.) is drafting legislation that would merge the CFTC, which has a reputation as a weak regulator, with the SEC and give the combined agency the authority to oversee over-the-counter contracts.

"I think the political climate in Congress doesn't allow for easy predictions," Erickson said. "But I do think there is greater interest in all these flaws that have been highlighted by the Enron episode.

"Is it the wisest public policy to have a financial market that is operating in a completely unregulated environment?" he asked. "Right now, for certain of our markets, we've embraced a choice that allows for closed and private markets. Personally, I think we can do better."



LOAD-DATE: February 22, 2002