Is Secrecy Essential to Stock Market Success? Transparency Rules Delayed

New transparency rules for the financial industry have been delayed.

June 16, 2011 -- When Congress passed a sweeping Wall Street finance reform bill last year it was supposed to shed some sunlight on the activities of hedge funds and the complicated derivatives that led to the financial crisis in 2008.

And one year after the bill's passage, and after tireless lobbying by the banking industry and the New York congressional delegation, the new rules have been postponed for six months. Regulators at the Commodities Future Trading Commission have until the end of December to work out the details and publish a final disclosure rule before companies have to comply.

How the rules are finally written and published will have a great effect on how transparent the financial industry will be forced to be.

"They can have a significant effect," said Dave Levinthal, who is a spokesman for the Center for Responsive Politics, referring to the recent lobbying efforts to water down the final rules.

And while Democrats voted for the financial reform, every single New York lawmaker has come out against the interpretation of the new derivative rules, including Sen. Charles Schumer, D-N.Y.

"We are concerned that these proposals will inevitably result in significant competitive disadvantages for U.S. firms operating globally. The proposals are inconsistent with congressional intent regarding the territorial scope of the new regulatory framework for derivatives," the lawmakers wrote in a joint statement.

Before the 2008 financial crisis, large private money groups, or hedge funds, used anonymity and complex mathematical formulas, or derivatives, to hide their investment strategies from the rest of the market.

Derivatives -- once a financial trading tool used by farmers to reduce the risk of growing a yearly crop in unpredictable weather -- were adopted by bankers on Wall Street years ago as a way to bet on everything from the price of corn to the supply of oil. Southwest Airlines used derivatives to lock in the price of airline fuel, making it cheaper to gas up its planes when oil price sky rocketed.

But reckless betting can leave collateral damage. Leading up to the housing crisis, many banks used derivatives to bet that people would always repay their housing debt. That's when the trouble began.

"Derivatives for a variety of reasons amplified the housing crisis and amplified the panic during the financial crisis," said Michael Konczal who is a research fellow at the Roosevelt Institute, a progressive think tank that consulted with Congress on financial reform.

The Dodd–Frank Wall Street Reform and Consumer Protection Act passed in 2010 requires companies that trade in some form of derivatives to register with the Commodities Future Trading Commission and to trade derivatives on an open exchange.

Reform minded thinkers argue that transparency in derivatives trading will bring stability to the market. They say that while price instability may bring gains to a few investors, that sharp price fluctuations have the potential to hurt everyday people.

New reforms would allow government regulators to see the entire derivatives market, and could allow them to forecast an impending crisis.

But some on Wall Street are afraid that too much transparency will give away their secret sauce.

"If you have a money-making machine or a money making strategy the last thing you want to do is blurt it out to the world," said John Jay who is a senior analyst at the Aite Group.

And with new rules coming into effect in the United States, many who are reluctant to adopt new rules here want similar rules passed in other countries -- the goal is to create a level playing field. Like companies that move their headquarters to the country with the lowest corporate tax rate, critics of the regulations fear that investors will simply move their operations to countries that have the least restrictive rules.

The Obama administration is in favor of derivatives reform but is also pushing for adoption of international derivative standards.

"The United States has taken an important leadership role in comprehensive reform of the over-the-counter derivatives market. Alignment with Europe and Asia is essential," said Treasury Secretary Timothy Geithner in Alabama at the International Monetary Conference.

Still, there are some in the financial community are tentatively behind the idea of transparency, such asthe Managed Fund Association, a trade group that represents hedge fund managers.

"Our members fully support improving transparency in the financial system, as well as ensuring that regulators receive the information they need to oversee the swap markets. We just ask that proprietary information given to regulators be adequately protected and kept confidential," said a spokesman for MFA.