October 3, 2008

SENATOR DODD. Mr. President, I rise to discuss the intent in Section 105 (c) of the Emergency Economic Stabilization Act of 2008, "Regulatory Modernization Report," of the important requirements for analysis of regulation of the over-the-counter swaps market and for recommendations regarding the enhancement of the clearing and settlement of over-the-counter swaps.

The OTC swaps market is enormous – estimated to be $600 trillion. This market is primarily made up of interest rate swaps and credit default swaps. Corporations, banks, insurance companies, GSEs, pension funds, State and local governments and endowments all participate in the OTC swaps market.

The OTC swaps market is a "bilateral contract" market which does not involve an exchange or a clearinghouse. It is directly between two parties – which results in each party bearing "counter party credit risk." In other words, if one of the two parties goes bankrupt or fails to pay, the other party can suffer a complete loss on the transaction.

Since the OTC swaps market has impacts on the financial system, it is appropriate and timely to look at it carefully. Some of the largest OTC swaps market dealers and market participants have been merged in federally arranged transactions into stronger market participants, taken into Government conservatorships or receiverships or provided a line of credit directly by the Federal Government. These actions were taken, in part, because of concerns by Federal authorities about either the losses in their OTC swaps books and or the potential cascading effect on OTC swaps market if such an entity failed.

The Treasury Report should look at the OTC swaps market generally and the current and potential options for improvements in clearing contracts, such as through a federally licensed clearinghouse, with a view to whether it would materially lower credit risk. The Report should consider issues such as the processing of confirmations, margining, collateral management, market access, transparency in pricing, and safety and soundness concerns.

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