First Impression of Gensler's OTC Derivatives Proposal

New CFTC chair Gary Gensler provided a much more detailed description of the administration's OTC derivatives reform proposal on Thursday. While we still don't have nearly enough information to render judgment on the proposal, let me just say that I'm extremely impressed so far. The administration—by which I primarily mean Tim Geithner and Gensler—seems to be striking exactly the right balance. While they could still go off the rails on any number of unresolved issues, you get the sense that they understand the derivatives markets too well to make any calamitous mistakes.

Obviously, a description of a new regulatory regime for OTC derivatives that's only 9 pages long is going to generate a lot of questions from the law firms. (I have a treatise on derivatives law and regulation that's over 2,000 pages long, so it's fair to say that Gensler's description leaves some things out.)

On a first read, the one question that jumps out at me as the most important is how the CFTC plans to use the authority to impose initial margin requirements on off-exchange customized derivatives. Are they planning on reviewing every customized derivative prior to settlement to determine whether initial margin requirements are needed? In other words, will dealers be required to get a green light from the CFTC on initial margins before they can settle a customized trade?

I highly doubt this is what the CFTC has in mind at this point, but when you consider the scheme the proposal sets up to make sure that derivatives that aren't cleared by a clearinghouse are truly "customized," things get a bit murkier. Presumably, off-clearinghouse derivatives can only be duplicated so many times before the CFTC deems them to be "standardized" and requires them to be traded through a clearinghouse. But if that's the case, then there would only be very limited circumstances in which the CFTC would ever impose initial margin requirements on a customized derivative—that is, unless they're planning on reviewing every customized derivative prior to settlement. Of course, that would likely be incredibly cumbersome, and could easily kill the bespoke market.

Anyway, that's the question that really jumped off the page at me. Aren't you glad you don't do this for a living?