Oral Testimony of Commissioner James E. Newsome Regarding the President's Working Group OTC Study and Long-Term Capital Management before the United States Senate Committee on Agriculture, Nutrition and Forestry

December 16, 1998

Mr. Chairman and members of the Committee, I am pleased to testify before you today regarding the President’s Working Group Over-the-Counter Derivatives Study and Long-Term Capital Management. I thank you for this opportunity. My comments will be brief and general, and I would request that my submission of written comments be included in the record of this hearing. The issues we are addressing today are at the forefront of discussions among and between financial market regulators and participants, and I applaud the Committee’s efforts to bring clarification and direction to this ongoing debate. Additionally, I look forward to hearing comments from the Committee on these issues.

Over the past decade, the over-the-counter marketplace has become increasingly important and attractive to the risk management requirements of financial market participants, not only in this country, but worldwide. The expanding nature of these markets, in size and complexity, has been driven by the necessities of global financial and business enterprise. The United States has enjoyed a vital role in this expansion and innovation, and I believe that with appropriate regulation, mindful of the free market principles that have given our economy its vitality and stability, such leadership by the United States in this area can and will continue. However, I believe just as adamantly that inappropriate or heavy-handed regulation will surely stifle financial market innovation, and send these important markets overseas. Accordingly, let me state the central and most important theme of my comments today: I believe it is imperative that legal certainty be restored to these vitally important markets. To that end, I reiterate the commitment in the September 11, 1998 letter to you, Mr. Chairman, in which Commissioner Spears and I affirmed that we would not vote to propose or issue any new rules, regulations, interpretations or policy statements to regulate swaps or hybrid instruments prior to Congress having the opportunity to review and analyze issues relating to OTC derivatives. I am gratified that this commitment of a majority of the Commission was subsequently codified by Congress, inasmuch as this gives concrete reassurance to markets and market participants, and serves considerably to decrease regulatory and legal uncertainly. Also, I agree with the proviso that the moratorium not interfere with the Commission’s ability to take action in furtherance of any determination by the President’s Working Group, and I am committed to prompt implementation of any action that the Working Group and Congress deem appropriate. Once again, let me emphasize my firm belief that these fundamental issues of regulation should be determined by Congress prior to any intervening regulatory activity.

Furthermore, I commend and fully support the requests made of the President’s Working Group on Financial Markets to undertake studies on OTC markets and on hedge funds. I look forward to cooperating with the other members of the Working Group and with the Steering Committee as we work on these studies, and I believe that these documents will provide significant insight and guidance on various issues to facilitate Congressional deliberation and determination. It is my understanding that several sections of both studies have been drafted, and that the hedge fund study should be completed early in the new year. It is my hope that the OTC study will subsequently be completed as soon thereafter as possible. Although neither I nor my staff have been personally involved in the Working Group or Steering committee discussions, at the appropriate time I would welcome such interaction, and I look forward to reviewing drafts of both studies, and to a joint effort by the Working Group members and their staffs.

As an important caution to this discussion, let me say that I believe it is premature to make any predictions about the conclusions of these studies prior to their completion. Similarly, I believe it imprudent to state overly broad opinions regarding the possible hazards or deficiencies of particular transactions or entities, prior to having the facts at hand to the fullest extent possible. Mr. Chairman, too often, the predicting of imaginable jeopardies becomes a self-fulfilling prophecy, and the issues we are contemplating are too important to put at risk with prognostication or supposition. With those qualifying factors in mind, I believe it may be beneficial to review certain questions as we proceed to carry out our work on these studies, such as promotion of best practices standards, possible enhanced disclosure of credit concentration, and study of risk modeling. Most importantly, I believe it is imperative to keep in mind that less intrusive, rather than more intrusive regulation is the desirable outcome of these endeavors.

Again, thank you Mr. Chairman for the opportunity to make these comments, and I would be happy to answer any questions.