May 19, 1999

Commodity Futures Trading Commission Chair Brooksley Born Tuesday warned Congress that the rapid growth of over-the-counter (OTC) derivatives may prove a risk to the U.S. economy and global financial stability. The OTC trading volume has been estimated at $70 trillion worldwide.

Born cited the case of Long-Term Capital Management L.P., a large hedge fund, that nearly defaulted last year on $1.25 trillion in notional value of exchange-traded and OTC derivatives contracts. That "episode demonstrates the unknown risks that the OTC derivatives market may pose to the US. economy and to financial stability around the world," Born told the House Agriculture Committee.

"It also illustrates the lack of transparency, excessive leverage and insufficient prodential controls in this market as well as the need for greater coordination and cooperation among domestic and international regulators."

The President's Working Group on Financial Markets is working on a study relating to OTC derivatives and has just completed a study of hedge funds and other highly leveraged institutions. Born is a member of the group.

Four "needs" are cited in the report in the aftermath of LTCM's near insolvency: the need for increased transparency, the need to eliminate excessive leverage, the need for better prudential controls and the need for enhanced international cooperation and harmonization of regulations.

"Although it is appropriate to await the recommendations of the (working groups study) on OTC derivatives before endorsing additional specific changes to the Commodities Exchange Act, it is clear that developments in the OTC market have implications that may merit future changes to the statutory framework," Born, who retires from the CFTC June 1, told the committee.