NU Online News Service, Oct. 7, 3:15 p.m.EDT

The chairman of the Commodities Futures Trading Commission todaycited American International Group as the poster child for the needfor strong regulation of the over-the-counter derivativesmarket.

Gary Gensler made his comments at a hearing before the HouseFinancial Services Committee on draft legislation, designed toimpose strong regulation on the swaps. The draft was prepared bythe staff of the FSC and released for discussion early this week byRep. Barney Frank, D-Mass., who chairs the committee.

Mr. Gensler also testified that AIG's problems highlight allfour of the reasons the swaps markets, that led to AIG's failure,must be brought under control.

First, those financial institutions that deal in derivativesshould be required to have sufficient capital, Mr. Genslersaid.

Second, swap dealers should be required to post and collectmargins for individual transactions.

Third, regulators should be able to mandate robust businessconduct standards to protect market integrity and lower risk, Mr.Gensler said.

"Fourth, where possible, OTC transactions should be required tobe cleared by robustly regulated central counterparties," Mr.Gensler said.

While Mr. Gensler opened the hearing by saying that through AIG,the financial system and federal regulators "failed the Americanpublic," the reaction to Rep. Frank's legislation to deal with theissue, was criticism for being too weak from regulators and membersof Congress.

For example, Mr. Gensler said the legislation should be amendedso that hedge funds or financial firms could not evade requirementsthat their derivative contracts go through centralclearinghouses.

Mr. Gensler also said the proposal does not clearly statewhether regulators would have to determine on a case-by-case basiswhether swaps would be subject to clearing.

Henry T.C. Hu, director of the SEC's new division of risk,strategy and financial innovation, added that "certain aspects ofthe discussion draft could unintentionally preserve existingregulatory gaps."

That forced Rep. Frank to say he will "tighten up" hislegislation to reduce loopholes in the rules cited by the critics."There are some areas here where there are gaps that shouldn't havebeen there," Rep. Frank acknowledged.

The Obama administration's proposed legislation to deal with theissue would mandate that all standardized derivative transactionsbe executed on an exchange or processed through a regulatedclearinghouse. This would impose collateral and margin requirementson trades.

The legislation proposed by Rep. Frank's bill would reduce thenumber of trades that would be forced to move to exchanges.

But Mr. Gensler's comments about AIG were the most dramatic partof the hearing on the draft legislation.

He called AIG "Exhibit A" of the failures of the financialsystem and the financial regulatory system last fall.

He said "AIG highlights the need for each of these fourpriorities. AIG was not required to meet capital standards or postmargins for individual transactions."

Moreover, "It was not subject to business conduct standards forits back office functions," he said. "AIG's failure was essentiallya failure of a central counterparty in the sense that itinternalized the credit risks of its trades," he added.

"Every single taxpayer in this room–both the members of thisCommittee and the audience–put money into a company that mostAmericans had never even heard of," he said in preparedremarks.

He noted that "approximately $180 billion of our tax dollarswent into AIG–that is nearly $414 million per each of yourcongressional districts," although AIG last week said that theamount it now owes the American people is $83 billion.

"While a year has passed and the system appears to havestabilized, we cannot relent in our mission to vigorously addressweaknesses and gaps in our regulatory structure," Mr. Genslersaid.

By moving bilateral trades into regulated clearinghouses, hesaid, "we will reduce the risk that a failure of one firm willcause other firms to fail as well."

He added, "Ineffective regulation allowed the failure of AIGFinancial Products and the derivative dealers affiliated withLehman Brothers, Bear Stearns and investment banks to affect theentire financial system.

"We must ensure that this never happens again. We cannot affordany more multi-billion-dollar bailouts," he concluded.