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GAO discussed federal oversight of derivatives activities. GAO noted that: (1) most of the over-the-counter (OTC) derivatives activity in the United States is handled by 15 major U.S. dealers who are extensively linked with each other, end-users, and the exchange-traded market; (2) these dealers' failures or abrupt withdrawals from trading would disrupt markets and expose others to risk; (3) the federal government would likely intervene to keep the financial system functioning in cases of severe financial stress; (4) an international financial organization and federal regulators have issued recommendations and guidelines for their derivatives dealers to enhance their risk-management practices, but there is no regulatory mechanism to ensure their compliance with these standards; (5) significant gaps and weaknesses in dealer regulation include limited regulatory authority over securities firms' and insurance companies' affiliates that deal in OTC derivatives, inadequate reporting requirements and testing of internal controls and systems, incomplete and inconsistent accounting standards for derivatives, and inadequate disclosure of derivatives activities; and (6) regulators must strike a proper balance between allowing the U.S. financial services industry to grow and innovate and protecting the safety and soundness of the financial system, which will require international cooperation among all interested parties.

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