Regulators Lift Barriers to Sale of Hybrid Securities
In a move welcomed on Wall Street, federal regulators Thursday cleared the way for investment banks and businesses to issue over-the-counter debt instruments that resemble futures and options.
The unanimous vote by the Commodity Futures Trading Commission lifted a cloud of legal uncertainty that had restricted use of the innovative instruments, which could be used to raise billions of dollars of capital.
The action was seen as a setback for futures exchanges, which have argued that U.S. law requires the financial instruments to be traded on federally regulated futures markets.
The approval was a victory for CFTC Chairman Wendy Gramm and the Reagan Administration, which has sought to remove regulatory barriers to the use of the financing techniques.
Fluctuating Value
At issue was the legal status of a category of debt securities or bank deposits called “hybrids” whose interest rates rise and fall with prices of commodities, like oil, or stock indexes.
Such securities in some ways resemble options and futures. Used often by firms primarily to hedge risk, futures are agreements to buy or sell a commodity for delivery in the future. Their value goes up and down as commodity prices change. Similarly, an option gives the buyer the right to buy or sell a commodity at a set price within a specified period of time. The value of the option fluctuates with the underlying commodity’s price.
The CFTC had authorized issuance of some hybrids on a case-by-case basis but never set broad guidelines on which over-the-counter, or non-futures exchange, hybrids were allowed.
The better known hybrids include debt notes issued in 1986 by Standard Oil Co. The return on the notes was pegged to the future price of West Texas intermediate crude oil.
On Thursday, the CFTC authorized immediate issuance of one category of hybrids already subject to U.S. bank or securities regulations, while requesting public comment on a proposal to allow eventual issuance of another kind.
In another regulatory decision Thursday, the Securities and Exchange Commission moved to streamline regulation of automated systems for trading stocks and bonds.
The Commission voted 5-0 to propose the rules, which are now open for public comment. The proposed rules would standardize regulatory treatment of the eight existing systems and clarify requirements for new ones.
These include automated systems for trading common stocks and bonds. Such setups are used by professional investors and operate on a for-profit basis.
