Regulating Australia's $78 trillion casino

The most dangerous markets in the world are the multi-trillion dollar derivatives casinos. In the US, the Federal Reserve has found itself unable to control these markets. If there was one bank board in the world that might have had the ability to understand what was happening on their trading floors it was J.P. Morgan. They have revealed just how limited their knowledge was of what their traders were doing and as a result dropped $5 billion. We have also seen how the Libor interest rate was rigged in the UK and that the US regulators knew what was going on.

Into this world the Australian Government has decided that it should honour a commitment in the 2009 G20 summit to make better regulation for over-the-counter (OTC) derivatives. In 2010-11 this was a $78 trillion market, according to the Australian Financial Markets Association.

The Minister for Financial Services and Superannuation, Bill Shorten, has this responsibility. Shorten has good intentions but this is the most dangerous task he will ever embrace because many of the players are totally self interested and cannot be trusted to have any concern for the wider community wellbeing. While I hope I am wrong, I fear that just as in the US, our bodies will be snowed.

We saw how the big investment banks used strong-arm tactics to pressure the ASX into allowing "legalised insider trading” so the investment banks could make money at the expense of Australian superannuation investors and other private investors (Turning the table on high-frequency traders, July 19).

They have used the same strong-arm tactics all around the world.

Very few Australian or international bank boards truly understand the risks they are being exposed to. They spend hours before each board meeting ticking boxes. We can see the potential of extreme damage being done to the system because if the Euro splits there will be enormous losses in the banking system and there is no certainty governments will have the ability, or willingness, to bail out the big traders. The global derivatives system is as good as its weakest link. I must emphasise that proper use of derivatives can lower risks but once banks start trading massive amounts it's simply a way of making money at high risk.

Understandably, the inclination of governments is to put really strong restrictions in place. But a lack of knowledge can trap you when you are under extreme pressure. As we saw with "legalised insider trading” the investment banks have so much power that they tell governments (or stock exchanges) that if they aren't internationally competitive they will be isolated from world markets.

As an illustration of their power, they have nobbled the American authorities. The New York Times reports that in July 2010, Congress passed a bill expanding the federal government's role in the markets, aiming to rein in abusive lending practices and high-risk bets on complex derivative securities. But as a result of intense lobbying by investment banks by September 2011, only a small portion of the law has taken hold. Of the up to 400 regulations called for in the act, only about a quarter had even been written, much less approved, according to the New York Times. At the same time, it is the Federal Reserve Bank of New York and not the Federal Reserve itself, that is on the front line of financial regulation. That process has been shown to have its inherent conflicts, as John Gapper of the FT argued this morning (Banking firemen won't stop fires, July 26).

But the New York branch of the Federal Reserve does not have enforcement power and instead, it reports potential wrongdoing to other agencies or the central bank. They decide if punishment is necessary. This division of authority is another victory for the investment banks.

Into this international mess strides Australia with a draft bill. In Australia our people will be under the same intense pressure that nobbled the Americans. I am not saying we should put it into the ‘too hard basket' but all those involved will have to recognise that they may not have the derivatives talents to counter the pressures.

That is in no way a criticism. It's simply a fact, which needs to be acknowledged. And it is a problem that will plague every regulator worldwide. Getting it wrong will have huge consequences.