UPDATE 1-Wall Street watchdog to ramp up scrutiny of risky derivative products

Adds context

By Katanga Johnson

WASHINGTON, May 11 (Reuters) – The chair of the U.S. Securities and Exchange Commission warned on Wednesday that the agency may bring more enforcement actions in cases involving risky derivatives, saying such products can create “system-wide risks” during times of market stress.

Last month, the agency brought charges against Bill Hwang, the owner of private fund Archegos, and other executives, alleging they engaged in fraud and market manipulation to create huge exposures to a handful of stocks using sophisticated equity swaps. nL3N2WP422

“Market participants’ use of derivatives touch so many parts of our markets, from SEC-registered funds wrapping these products in publicly offered strategies, to numerous private funds using derivatives at significant exposure levels,” SEC Chair Gary Gensler told an industry audience on Wednesday.

“The use of derivatives can present unique and potentially significant risks to investors across market sectors … even to sophisticated investors, and can potentially create system-wide risks by operating in unanticipated ways when markets experience volatility or stress conditions,” he added, citing recent enforcement actions against such behavior.

“There may be more (enforcement actions) to come.”

U.S. and British financial regulators have been in discussions with market players including broker-dealers as they try to determine the fallout from the Archegos default.

Even more, Gensler’s comments breath new life into a long-running project at the SEC to apply stricter oversight to the securities portion of the derivatives market, as directed by the 2010 Dodd-Frank financial reform law.

The Commodity Futures Trading Commission has the bulk of responsibility for overseeing derivatives, but the SEC has lagged in its efforts to write required rules for the relatively small portion of the securities-based derivatives market.

Separately, Gensler also warned that swaps based on cryptocurrencies would generally be considered reportable security-based swaps under its rules.

“Without prejudging any one token … if a swap is based upon a crypto asset that is a security, then that is a security-based swap. Thus, our rules apply to them,” he said.

(Reporting by Katanga Johnson in Washington
Editing by Paul Simao)

((Katanga.Johnson@tr.com; 202-579-4165; Reuters Messaging: @kjspeakstruth))