1 See Memorandum to Investment Advisers Committee No. 5-95 and SEC Rules Committee No. 7-95, dated
January 17, 1995.
February 2, 1995
TO: INVESTMENT ADVISERS COMMITTEE No. 9-95
SEC RULES COMMITTEE No. 16-95
RE: CONGRESSMAN GONZALEZ INTRODUCES DERIVATIVES LEGISLATION
______________________________________________________________________________
Congressman Henry Gonzalez (D-TX), the Ranking Minority Member of the House
Banking Committee, recently introduced H.R. 31, the "Derivatives Safety and Soundness
Supervision Act of 1995." The bill, which is summarized below, is similar in many respects to
the proposed derivatives legislation introduced by Congressman Leach that previously was
circulated to you.1 Unlike the Leach bill, however, the Gonzalez bill expressly would cover
investment companies and investment advisers. A copy of H.R. 31 is attached.
Title I of the bill would require the "appropriate Federal regulatory agencies" (defined to
include, among others, the federal banking agencies, the SEC, the CFTC, the Federal Reserve
Board and the Treasury Secretary) to consult with each other and establish "substantially
similar standards" with respect to capital, accounting, disclosure, risk management and
suitability in connection with the supervision of "financial institutions" engaged in "derivatives
activities." "Financial institutions" are defined to include investment companies and
investment advisers, among other entities. "Derivatives activities" include activities in which a
financial institution is engaged as an "active end-user," which in turn is defined to mean a
financial institution that "buys or sells a significant amount of derivative financial instruments,
or conducts transactions in a wide variety of derivative financial instruments."
The bill lists certain factors to be considered, in establishing the new regulatory
standards referred to above, that are largely identical to those included in the Leach bill. One
notable exception is that the Gonzalez bill, in contrast to the Leach bill, would not require
consideration of the need for enhanced risk disclosures to investors in mutual funds that invest
in derivatives.
The bill would authorize federal bank regulators to require insured depository
institutions to disclose in call reports certain quantitative and qualitative information
concerning derivatives, and would authorize other federal regulators to adopt similar quarterly
reporting requirements for "financial institutions" that are not insured depository institutions.
Title II of the bill would prohibit a "financial institution" from engaging in derivatives
activities unless it has in place a written management plan approved by the board of directors
which, among other things, ensures that the activities are "conducted in a safe and sound
manner" and establishes prudential standards for the management of the risks involved in such
activities and a framework for internal controls with respect to such activities. It would require
that the directors of a "financial institution" be informed of the risks associated with the
institution’s derivatives activities and the "total current credit exposure" of the institution with
respect to such activities. Similar to the Leach bill, the Gonzalez bill includes a provision
specifying that the failure of an "institution-affiliated party" engaged in derivatives activities to
have adequate technical expertise with respect to such activities may be treated by the
appropriate Federal regulatory agency as an unsafe or unsound practice in conducting the
business of the institution. In addition, like the Leach bill, the Gonzalez bill provides for
confidential reporting of information about derivatives activities to reglators in the case of
adverse market conditions or other emergency situations.
Title III of H.R. 31, like Title III of the Leach bill, is designed to clarify the status of and
rights of parties to certain derivative financial instruments in the case of the insolvency of an
insured depository institution that is acting as counterparty.
The Gonzalez bill also would require a study of international regulation and
supervision of derivatives activities of financial institutions (led by the Secretary of the
Treasury) and encouragement of international negotiations to work towards maintaining and
adopting comparable supervisory standards and regulations. In addition, the GAO would be
required to undertake a study of "the speculative uses of derivative financial instruments by
financial institutions and the feasibility of imposing margin and collateral requirements on
speculative transactions engaged in by financial institutions which involve derivative
instruments."
It is anticipated that the House Banking Committee will schedule hearings on
derivatives legislation although it is not clear when. If you have any comments on the
attached bill, please call me at (202) 326-5822 by Wednesday, February 15th.
Frances M. Stadler
Associate Counsel
Enclosure