Derivatives market will no longer be uncontrolled? Geithner wants overhaul

New regulation of the financial system was proposed to the U.S. Congress in a two-page letter sent Wednesday by Treasury Secretary Timothy Geithner. The letter shows that the Obama administration wants the lawmakers to extend its oversight of the financial industry to include market of derivatives, the kind of complex financial instruments that helped bring down the giant insurer AIG.

Addressing the Congress Geithner said in his letter that he wants to create a central electronic-based system that would track the buying and selling of derivatives. He also wants to ensure that financial firms selling the instruments have enough capital on hand in case they default and subject them to stringent standards of conduct and new reporting requirements.

"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," Geithner wrote in his letter.

"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," he adds.

How the new regulation will affect hedge funds remains unclear. Many hedge funds use derivatives contracts to offset risk on other transactions.

Critics of such oversight claim that the new legislation would give more power to those financial institutions who greatly contributed to the global collapse.

Current law largely excludes regulation of the instruments, which are referred to as "over-the-counter" derivatives because they are traded privately rather than through commodity exchanges now regulated by the Commodity Futures Trading Commission.

The plan offered by Geithner specifies that the CFTC would establish an "audit trail" for the derivatives and have "clear unimpeded authority to police fraud, market manipulation and other market abuses" involving the derivatives. The Securities and Exchange Commission would be given comparable authority, including tools to prevent insider trading.

Geithner said that the new system should enable the regulators to "detect and deter all such market abuses.”