A Williams Act for Derivatives

One reason I’ve often thought that the benefits of moving credit derivatives to a central clearing house/exchange model have been oversold turns on the ability to move trades offshore. This is highlighted in an excellent article in today’s FT, in which a trader states that if the US and EU regulations become too tough, trading will move to “Switzerland and Singapore.”

Why not require disclosure of derivative-related information, regardless of the jurisdiction where the trading takes place? For example, the SEC could require all reporting companies to disclose (a) any counterparties who make up more than 5% of the reporting company’s derivative portfolio and (b) any reference entities or asset classes that are the subject of more than 5% of the company’s credit derivative portfolio.  Specific trading strategies and positions need not be disclosed; the foregoing information would be sufficient to gauge whether the company was engaged in appropriate risk management (i.e., making sure that it was not getting all of its credit protection from AIG).

If the reporting obligation extended to the reporting company and all affiliates, such a rule could provide an important check on the “Switzerland and Singapore” strategy -- at least so long as the US and the EU have subtaintially deeper capital markets than either of those nice, but small, jurisdicitons.

Comments

[Adam Levitin]

The trading flight seems like an analogy to the post-SOx listing debate, which has always puzzled me. Isn't there a possibility of a listings equilibrium: those firms that list in the US will have higher regulatory costs, but those might be offset by lower costs of capital due to the reputational bonding of US listing? Methinks there's no good way to test this, but I'm not particularly troubled by companies listing abroad or by a flight of derivatives trading. There are costs to doing business abroad, and that may offset some of the flight.

[Stephen Lubben]

Adam: isn't the problem here different, inasmuch as CDS trading by AIG's guys in Zurich might bring down the rest of the company, necessitating a bailout. In short, unlike SOX, a firm is not faced with a binary choice (stay in the US or leave), and what happens abroad can create systemic risk here.