Geithner To Call for Policing of Derivatives

U.S. Treasury Secretary Timothy Geithner will tell Congress Friday that the "enormous scale and the critical role" of over-the-counter derivatives in the financial markets as well as their their "substantial challenges and risks" require greater government regulation.

CNBC.com Treasury Secretary Timothy Geithner

Geithner will also recommend that the Securities and Exchange Commission and the Commodities Future Exchange Commission share the new oversight powers, according to the testimony, a copy of which was obtained by CNBC.com.

"Establishing a comprehensive framework of oversight for the OTC derivative markets is crucial to laying the foundation for a safer, more stable financial system,” the testimony reads.

The Treasury Secretary is scheduled to appear at 10 a.m. ET before a joint hearing of the House Financial Services and Agriculture Committees, which are looking into the oversight issue.

Geithner's testimony cites the "explosive growth" of derivatives during the past decade, estimating that their total market value peaked at some $20 trillion during the height of the recent boom. At the same time, adequate capital to back the instruments was not required in some cases.

OTC derivatives are tailor-made financial instruments, which are not traded on futures exchanges, and are created by investment banks and other financial firms and sold to various customers such as hedge funds.

Enhanced oversight of derivatives is part of the Obama administration's sweeping plan for regulatory reform of the financial system, which is meant to avert another crisis.

In seeking greater overall transparency to prevent abuse and protect investors, the administration would require "all standardized derivative contracts be cleared through well-regulated central counterparties and executed either on regulated exchanges or regulated electronic trade execution systems."

In doing so, the SEC and CFTC will have the authority to impose record keeping  and reporting requirements on all OTC derivatives. They will also have "clear authority" over civil enforcement and regulation of fraud, market manipulation, and other abuses.

Democrats in Congress generally support stepped-up oversight of the derivatives markets but many Republicans are wary about potential overkill, saying the financial instruments allow companies to minimize risk, which in turn helps consumers in the form of lower prices for many commodity-based products.

Geithner's proposals are likely to be challenegd by GOP panel members today.

“Mandating the use of central clearinghouses for derivatives contracts has the potential to restrict liquidity in the marketplace, limit the ability of businesses to hedge their unique risk and tie up capital that could be used to promote business development," said New Jersey Rep. Scott Garrett, of the House Financial Services panel, aheaad of the hearing.

In February the Agriculture Committee approved by voice vote legislation that would amend the existing Commodity Exchange Act by requiring most OTC commodities be settled and cleared on a formal exchange  regulated by either the SEC or CFTC. The legislation, however, would make the CFTC the primary regulator.

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