With a new commissioner, Gary Gensler, now at the helm of the Commodity Futures Trading Commission (CFTC), the agency likely will head in a different direction than it has in the past. “Gensler clearly is in the Obama camp and very activist from the point-of-view of wanting to re-regulate,” says Michael Gorham, a professor and director of the Stuart Center for Financial Markets at the Illinois Institute of Technology. Gorham also was the CFTC’s director of market oversight for several years starting in mid-2002.

To be sure, it’s not just a changing of the guard that’s prompting this shift. The massive growth in the volume of derivative transactions also comes into play. According to the Bank for International Settlements, the gross market value of over- the-counter (OTC) derivatives in the G10 countries and Switzerland nearly quadrupled between December 2006 and December 2008, rising from U.S. $9.8 trillion to U.S. $33.9 trillion.

The amount of derivatives cleared through exchanges jumped as well, although not as dramatically. The number of contracts rose from about 9 billion in 2004 to 18 billion in 2008, according to the Futures Industry Association.

The role that the derivatives markets played in the financial meltdown of the past 18 months also is prompting Gensler and other regulators to rethink just how they oversee these instruments. In a statement in a joint meeting with the Securities and Exchange Commission on September 2, Mr. Gensler said, “I look forward to working with Congress and the SEC to establish authorities to regulate all OTC derivatives.”

He reiterated his support for regulation of the OTC derivatives market in additional remarks he made a few weeks later.

While it’s not clear that all OTC derivative transactions will be pushed to exchanges, they may be put into a clearing mechanism, Gorham says. Both parties would submit the trade to a clearing house and post margins, or performance bonds. Each day, the parties also would have to mark their accounts to the market, and put money into their accounts if the market went against them. While this protects both sides from the risk that the other may default, it also uses up cash that the company may want to allocate elsewhere. As a result, a number of companies oppose to the idea, as I noted in a previous post.

One other proposal that is not likely to move forward at the moment is the idea of merging the SEC and CFTC, Gorham says. “My impression is that it’s unlikely to happen this time around.” For starters, the members of Congress who oversee these two agencies – CFTC reports to the agricultural committees in the House and Senate, while the SEC reports to financial services committees – all want to hang on to their respective turfs.

In addition, the culture at the two agencies varies significantly, Gorham notes. The SEC tends to take a rules-based approach to regulation, while the CFTC focuses on core principles and lets the entities it oversees determine how to reach them. While the CFTC’s way of doing business appears to be more effective, it would be difficult for the agency, which is about one-sixth the size of the SEC, to impose its will on a combined organization.

In theory, however, combining the two agencies makes a great deal of sense, as this article in the Los Angeles Times points out. Having a single combined agency, which is the norm in the rest of the world, would reduce the likelihood that a category of securities could find itself outside the regulatory reach of either organization. That’s what happened with some derivatives, Gorham says. “It wasn’t clear who regulated credit default swaps.” We’ve all been living with the consequences of that lack of clarity. ###