MercoPress. South Atlantic News Agency

US Treasury moves to regulate complex (lethal) financial instruments

Treasury Secretary Timothy Geithner

The United States Treasury wants more regulation of derivatives - the complex financial instruments that brought down some of Wall Street's biggest names. Proposals to be set out by Treasury Secretary Timothy Geithner will call for an electronic system to monitor buying and selling in the market.

Firms trading in derivatives will need enough capital in case they default and will face tough reporting requirements.

AIG and Lehman Brothers were among the firms ruined by dealing in derivatives.

Perhaps the most notorious form of derivative is the credit-default swap.

Insurance giant AIG sold these to investors as a form of insurance to protect against defaults on mortgage-backed securities. But the firm had to accept a hefty federal bailout after it was unable to support the contracts.

Under the Treasury's plan, the likes of AIG would have to prove they had enough reserve capital to support their sale of the derivatives.

These measures would reduce risk to the financial system, Mr Geithner said.

Existing US law largely excludes regulation of such instruments - referred to as “over-the-counter” because they are privately traded.

“The days when a major insurance company could bet the house on credit default swaps with no one watching and no credible backing to protect the company or taxpayers from losses must end,” Mr Geithner told Congress.

In a draft letter, to congressional leaders, the Treasury said that ”all (over-the-counter) derivatives dealers and all other firms whose activities in those markets create large exposures to counterparties should be subject to a robust regime of prudential supervision and regulation“.

”Key elements of that robust regulatory regime must include conservative capital requirements, business conduct standards, reporting requirements and conservative requirements relating to initial margins on counterparty credit exposures,” the department added.

Derivatives are basically financial contracts which are a way of allowing traders to hedge their bets.

They can protect companies and banks against unexpected developments, for example sudden falls or rises in the value of currencies or commodities.

Derivatives are also used in speculation, whereby investors can increase profit if the value of the underlying contract moves in the way they expect.