House derivatives 2009

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See also credit default swaps, CDS clearing, CDS confirmation, CFTC, derivatives, derivatives concentration, muni swaps and regulatory harmonization

Contents

Senate versions

  • --- Proposed versions of derivatives legislation (as of 4/16/10)

House versions

See also CDS clearing, CDS confirmation, Credit default swaps, CFTC, Derivatives, and Regulatory harmonization.

House 2009 legislative activity

Senior lawmakers near swaps crackdown consensus

Senior Democratic lawmakers have agreed on all but a few details of a plan for over-the-counter derivatives regulation, suggesting consensus is near on one of the trickiest parts of the Obama administration's effort to tighten U.S. financial oversight.

Draft legislative language obtained by Reuters on Sunday shows the chairmen of two House of Representatives' financial committees want OTC derivatives to be centrally cleared and traded on exchanges or other platforms where possible.

The draft language -- reflecting a compromise between House Financial Services Committee Chairman Barney Frank and House Agriculture Committee Chairman Collin Peterson -- resembles a bill unveiled last month by Senator Christopher Dodd.

Dodd chairs the Senate Banking Committee, which is handling financial reform efforts. Peterson and Frank have worked for weeks on their 227-page amendment, to be offered this week on the House floor as part of a sweeping reform bill.

The House is expected to pass the broader bill, with the OTC derivatives language, possibly as soon as Friday.

That would throw the reform effort, now more than a year old, fully onto the shoulders of the Senate, which is expected to debate the many issues surrounding it well into 2010.

Both clearing and exchange trading are meant to hold more accountable a $450 trillion market, now unregulated, which is widely blamed for aggravating last year's financial crisis.

Financial services industry interests fear new regulations will increase their costs, cut their profits and frustrate companies' ability to manage risk. The U.S. Chamber of Commerce, for instance, wrote to lawmakers on Friday saying legislation could hamper major pension funds' operations.

OTC derivatives are financial contracts that now trade off-exchange among the biggest financial institutions and so-called end users, such as airlines and agribusinesses.

Goldman Sachs, JPMorgan Chase, Citigroup, Bank of America and Morgan Stanley dominate the derivatives market and reap huge gains from it.

The market includes credit default swaps. Former insurance giant AIG got into deep trouble after it sold hundreds of billions of dollars worth of these swaps, triggering a massive taxpayer bailout under the Bush administration.

BALANCING ACT

Much OTC derivatives trading involves financial firms placing bets on changes in debt defaults, interest rates and commodity or stock prices, but businesses also use it to hedge against risks affecting costs for fuel and other commodities.

Lawmakers have been trying for months to balance a desire to curb speculative excess while preserving the market's useful role in helping corporations hedge against operational risks.

Two issues that Frank and Peterson could not agree on remain to be decided on the House floor -- whether to limit ownership in swaps clearinghouses, and whether regulators would have the power to set margin and capital requirements on swaps traded by nonfinancial end users, House aides said.

Clearinghouses stand between parties to a trade and assume the risk if one of the parties fails. These middlemen usually require both counterparties to front collateral, a cost that end users of swaps say they would be hard-pressed to meet.

Frank and Peterson want swaps to be centrally cleared when a clearinghouse will accept them, and when regulators determine clearing is necessary.

Swaps not accepted for clearing would have to be reported to a swap repository or regulators.

In an important exemption for end users, clearing could be waived when one counterparty "is not a swap dealer or major swap participant" or is "using swaps to hedge or mitigate commercial risk." Frank, Peterson and Dodd agree on this.

Swaps that are cleared must be traded on an exchange or a registered execution facility, Frank and Peterson proposed.

If that's not possible, counterparties must meet recordkeeping and reporting requirements. Regulators would write rules to prevent abuse of the exemption for end users and set position limits, as well, "to diminish, eliminate, or prevent excessive speculation."

Frank and Peterson want to prohibit government support for a troubled clearinghouse, as well, except "where explicitly authorized by an act of Congress."

The administration is under international pressure on the issue. The G20 group of countries has agreed that OTC derivatives should trade on an exchange or platform, where appropriate, and clear centrally by the end of 2012.


Regulators to decide whether products centrally clear


U.S. regulators should be given authority to determine whether a privately traded derivative contract should be cleared through a central clearinghouse, the chairman of the House Financial Services Committee said on Tuesday.

The move would be highly controversial as clearinghouses, which stand between parties to the trade and assume the risk of the failure of one of the parties, have maintained they should have the right to determine what contracts they clear and they have expressed reluctance about clearing risky contracts.

The congressional panel has approved a bill to regulate the $450 trillion over-the-counter derivatives market, after credit default swaps (CDS) were blamed for exacerbating the global financial crisis.

But Financial Services Committee Chairman Barney Frank said he wanted to change the bill to take authority to determine whether swaps are clearable away from private clearinghouses.

“I am having staff prepare an amendment to give that function back” to the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), Frank told reporters.

Under Frank’s bill, private clearinghouses, some of which are owned by financial institutions, have the power to determine whether a swap can be cleared.

But in a potential loophole, financial firms, which oppose the mandate that certain derivatives be traded, might have an incentive to not declare trades clearable, Frank told reporters.

The change will likely face opposition from market participants who have said that clearinghouses should have the option to decline risky or hard to value assets if they are put at risk of failing themselves.

“If central counterparties are forced to clear something they don’t feel comfortable with, we’d end up creating new systemic risk rather than reducing it,” said Kevin McPartland, senior analyst at TABB Group in New York.

Frank also said trading between financial institutions will need to be made on exchanges, without exemption. This rule would cover all banks that have traded with American International Group <AIG.N>, which he deemed “the poster child” of derivative problems.

AIG needed a government bailout out after selling hundreds of billions of dollars of protection on risky assets using CDSs.

Frank said he and House Agriculture Committee chairman Collin Peterson are very close to a deal to merge both panel’s bills.

SYSTEMIC RISKS Clearinghouses concentrate the exposures of large trading counterparties, and pose large risks to the financial system if they are undercapitalized.

Derivative contracts can be used to hedge against or bet on the changes in value of the underlying assets such as stocks, bonds, commodities.

Enforcing margin requirements on many derivatives, such as credit default swaps, can be challenging as the value of the contracts can rapidly change if a borrower is suddenly deemed near default. In some cases defaults can occur before sufficient collateral payments can be made.

“There’s a fairly significant risk that if a regulator decides they have to clear something and can set capital or otherwise determine how to appropriately clear a product, we have succeeded in just pushing risk to clearing corporations and raised the risk that they may not have adequate capital,” said Paul Forrester, partner at law firm Mayer Brown in Chicago.

“That’s a potentially larger problem than the one we’re trying to solve,” he said.

Executives at CME Group Inc and LCH.Clearnet, both of which plan to clear credit default swaps, have said they are wary of clearing contracts that trade infrequently or have few pricing sources. For details, see

Frank said he also requested the change in a letter to CFTC Chairman Gary Gensler. The full House still needs to vote on the bill, and the Senate must agree before president Barack Obama could sign it into law.

House Agriculture Committee passes bill

"The House Agriculture Committee approved legislation regulating over-the-counter derivatives after adopting a provision that may speed agreement on regulation of the $592 trillion industry.

The amendment by committee Chairman Collin Peterson would exempt end-users -- companies such as manufacturers and airlines that employ derivatives to hedge their operational risks -- from increased capital, trading and disclosure requirements.

“In crafting this bill, our target for greater regulation and oversight is not the end-user but their swap dealer or major swap participant counterparty,” Peterson, a Minnesota Democrat, said during debate on the bill. “End-users did not get a bailout of billions of dollars. End-users are not responsible for what happened in markets last year.”

The legislation was approved by voice vote. The House Financial Services Committee approved a bill on Oct. 15 with a similar exemption for end-users.

House Financial Services Committee passes bill

"The House Financial Services Committee today approved legislation that would, for the first time ever, require the comprehensive regulation of the over-the-counter (OTC) derivatives marketplace. Today’s bill, which was approved by a vote of 43-26, represents a key part of a broader effort by Congress and President Obama to modernize America’s financial regulatory system in response to last year’s financial crisis.

Under the bill, all standardized swap transactions between dealers and large market participants, referred to as “major swap participants,” would have to be cleared and must be traded on an exchange or electronic platform. A major swap participant is defined as anyone that maintains a substantial net position in swaps, exclusive of hedging for commercial risk, or whose positions creates such significant exposure to others that it requires monitoring. OTC derivatives include swaps, which are contracts that call for an exchange of cash between two counterparties based on an underlying rate, index, credit event or the performance of an asset.

The legislation then sets out parallel regulatory frameworks for the regulation of swap markets, dealers, and major swap participants. Rulemaking authority is held jointly by the Commodity Futures Trading Commission (CFTC), which has jurisdiction over swaps, and the Securities and Exchange Commission (SEC), which has jurisdiction over security-based swaps. The Treasury Department is given the authority to issue final rules if the CFTC and SEC cannot decide on a joint approach within 180 days. Subsequent interpretations of rules must be agreed to jointly by the Commissions.

Description of the Over-the-Counter Derivatives Markets Act of 2009


House Committee on Agriculture draft of proposed legislation


House Fin Service Committee draft of proposed legislation


Concept paper for OTC derivatives legislation

Source: Chairmen Peterson and Frank's "Description of Principles for OTC Derivatives Legislation" July 30, 2009

Chairman Peterson said: “I am pleased that Chairman Frank and I were able to come to agreement on so many principles with regard to OTC derivatives reform. I think we have come up with a responsible approach that bridges the differences between those members who want to completely eliminate the over-the-counter market and those who think that just greater transparency is all that is needed. Neither of those approaches is a real solution; what we are putting forth is.

“Putting this concept paper out now will give members of both Committees plenty of time to review it, develop ideas, suggestions, thoughts and comments so everyone will be prepared to tackle these issues when we return in September. I look forward to working with Chairman Frank so we can enact legislation that gives the American people the confidence that our markets are being overseen and monitored by strong, effective regulators.”

Chairman Frank said: “The fundamental purpose here is to improve the regulation of derivatives so that they continue to perform their important market function but are less likely to contribute to a kind of irresponsibility that can cause a crisis. Nobody here wants to ban them or even severely diminish them as an economic instrument. The Committee on Agriculture represents a lot of end users for whom they are very important. The Committee on Financial Services deals with a lot of the financial institutions. They have an interest that has to be blended. I thank Chairman Peterson and his staff for their cooperation on this effort.”

Robust Oversight of Dealers and Markets

Depending on the underlying asset on which a derivative is based, either the SEC or the CFTC, or potentially both, will oversee the regulation of OTC derivative dealers, exchanges and clearinghouses.

    • Clearinghouse Regulation: Clearinghouses will be robustly regulated. Primary oversight authority of the CDS clearinghouse, ICE Trust, will be shifted from the Federal Reserve to a market regulator after a period not longer than six months from the date of enactment.
    • Trade Reporting: All OTC derivative trades must be reported to a qualified trade repository.
    • Regulatory Approval: Requests for approval as a clearinghouse, exchange or electronic trading platform must be acted on by the relative agency within 180 days.
    • Regulatory Harmonization: The statutory and regulatory powers of the SEC and CFTC shall be harmonized with respect to the OTC derivative market including registration requirements for dealers.

Mandatory Clearing of OTC Derivatives

Derivatives must be cleared by an approved clearinghouse. Exchange trading and trading on electronic trading platforms will be strongly incentivized and encouraged.

Exceptions:

    • Appropriate regulator determines the product is not sufficiently standardized to be cleared or no qualified clearing mechanism exists.
    • One party in the transaction does not qualify as a “major market participant” as determined by the appropriate regulator in consultation with the Financial Services Oversight Council.

Regulators should have:

    • Authority to prohibit or regulate transactions that are not traded on exchange or cleared.

Strengthening Capital and Margin Requirements

  • Appropriate regulators will develop margin and capital requirements that create a strong incentive for dealers and users of derivatives to trade them on an exchange or electronic trading platform or have them cleared whenever possible.
  • Significantly higher capital and margin charges will apply to non-standardized transactions that are not exchange-traded or centrally cleared.
  • Regulators can authorize use of non-cash collateral to satisfy margin requirements.

Particular Attention to Speculation

At least two options will be considered:

1. Limitation on Speculation

Prohibition on any purchase of credit protection using a CDS contracts unless:

    • The party owns the referenced security or (one or more) of the securities in an index of securities.
    • The party has a bona fide economic interest that will be protected by the contract.
    • The party is a bona fide market maker.
    • Regulators will have authority to monitor market activity and impose position limit where necessary.

2. Enhanced Oversight of Speculative Positions

Require confidential reporting to the appropriate regulator of all short interest in CDS contracts by:

  • OTC derivatives dealers;
  • Investment advisers that manages in excess of $100 million;
  • Other entities that are deemed “major market participants”.

In order to prevent abuse, the appropriate regulator has authority to:

  • Impose position limits on market participants;
  • Ban the purchase of credit protection using CDS by any non-dealer that is not hedging a risk.

Protect U.S. Financial Institutions from Lesser Regulatory Standards in Other Countries

  • U.S. regulators will coordinate with foreign regulators on harmonizing OTC derivative market regulation including recognized international standards with respect to clearinghouses.
  • The Treasury Department will be authorized to restrict access to the U.S. banking system for institutions of any jurisdiction Treasury finds permits capital-related standards that are lower than the United States or that promote reckless market activity.

Role of Financial Services Oversight Council

  • Resolve disputes between the SEC and CFTC over authority over new products within 180 days.
  • Resolve disputes between the SEC and CFTC over joint regulation of derivative products within 180 days.

Enforcement

  • Agencies shall have enforcement authority over products under their jurisdiction.
  • Agencies shall hold enforcement authority jointly for any products subject to joint jurisdiction.

House Financial Services Committee hearing October 7

Watch archived video of hearing here.

Witnesses:

  • The Honorable Gary Gensler, Chairman, Commodity Futures Trading Commission
  • Mr. Henry Hu, Director, Division of Risk, Strategy, and Financial Innovation, U.S. Securities and Exchange Commission

For additional witness statements go here.

House Agriculture Committee hearing September 22

RE: To review proposed legislation by the U.S. Department of Treasury regarding the regulation of over-the-counter derivatives markets, part one.


Media coverage

House Agriculture Committee hearing September 17

House Agriculture Committee hearing September 17, 2009

10:30 a.m. 1300 Longworth House Office Building, Full Committee – Public Hearing

RE: To review proposed legislation by the U.S. Department of Treasury regarding the regulation of over-the-counter derivatives markets, part one.


  • Mr. Daniel N. Budofsky, Davis Polk & Wardwell LLP, on behalf of the Securities Industry and Financial Markets Association, New York, New York

"Congress should only require mandatory clearing of standardized interdealer over-the-counter derivatives transactions in which at least one of the dealers is systemically significant, the chief executive officer of the International Swaps and Derivatives Association told lawmakers yesterday.

Both the Treasury Department’s proposed legislation and a bill sponsored by the chairmen of the House Financial Services and Agriculture committees would mandate central clearing and exchange trading of standardized derivatives contracts.

But Robert Pickel, the ISDA’s CEO, told members of the House Agriculture Committee yesterday, “Not all standardized contracts can be cleared.”


Joint hearing Agriculture Financial Services hearing July 10

Joint Committee hearing of the House Agriculture and House Financial Services Committee announced for Friday, July 10th at 10:00am. Treasury Secretary Geithner to testify (testimony link).

"Frank, in an interview with MSNBC (running time 5:35) after the hearing, said he would further limit the ability of businesses to enter into individualized derivative contracts.

"We will specifically be requiring that in almost every case derivatives go on an exchange ... or a clearinghouse, that there not be these individualized deals," he said. "And if people are going to make individualized deals, they're going to have to have a lot more capital behind it. "

Frank also said he would call for a ban on so-called naked credit default swaps, a type of derivative where buyers have no risk of exposure.

Some Democrats have called for fewer customized derivatives contracts and a few have urged that some derivatives, such as credit default swaps, be banned."

"A major battle is brewing, however, over definitions. At root it boils down to how regulators and the market determine the difference between a standardized derivative and a customized derivative.

In his testimony before a joint hearing of the House Financial Services Committee and House Agriculture Committee, Geithner said that the administration would use a “broad definition” of standardized derivatives that would be “difficult to evade.” The administration proposal would raise capital requirements for customized derivatives, “given their higher levels of risk.”

Geithner said that the administration would likely recommend broad principles in statute and then define them further in regulation.

Banks and a range of other non-financial firms are lobbying heavily on derivatives legislation, which is one part of the administration’s plan to revamp regulations for the wider financial system.

Four major Washington lobbying associations -- Business Roundtable, U.S. Chamber of Commerce, National Association of Manufacturers and The Association of Food, Beverage and Consumer Products Companies -- wrote in a letter on Friday that the proposal would increase the cost of business. “We urge you to prevent an anti-derivatives sentiment from translating into anti-business legislation,” the associations wrote.

A separate letter from 15 associations representing the electric power and natural gas industries raised concern with the mandatory clearing provision and the effort to move OTC derivatives onto public exchanges. The proposals, the associations said, would “significantly increase costs,” and “greatly reduce the ability of companies to find the customized derivative products they need to manage their risks.”

HR 977 --Agriculture Committee

The House Agriculture Committee approved H.R. 977 - which has been deferred indefinitely

  • -- Require most non-exchange (OTC) derivatives to be settled through a registered CCP
  • -- Gives the CFTC some authority to suspend trading in CDS

HR 2454 Energy Committee

The House Energy Committee approved H.R. 2454 (deferred to other Committees)

-- Includes prohibition of "naked" CDS sales


Regulators to decide whether products centrally clear


U.S. regulators should be given authority to determine whether a privately traded derivative contract should be cleared through a central clearinghouse, the chairman of the House Financial Services Committee said on Tuesday.


The move would be highly controversial as clearinghouses, which stand between parties to the trade and assume the risk of the failure of one of the parties, have maintained they should have the right to determine what contracts they clear and they have expressed reluctance about clearing risky contracts.

The congressional panel has approved a bill to regulate the $450 trillion over-the-counter derivatives market, after credit default swaps (CDS) were blamed for exacerbating the global financial crisis.

But Financial Services Committee Chairman Barney Frank said he wanted to change the bill to take authority to determine whether swaps are clearable away from private clearinghouses.

“I am having staff prepare an amendment to give that function back” to the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), Frank told reporters.

Under Frank’s bill, private clearinghouses, some of which are owned by financial institutions, have the power to determine whether a swap can be cleared.

But in a potential loophole, financial firms, which oppose the mandate that certain derivatives be traded, might have an incentive to not declare trades clearable, Frank told reporters.

The change will likely face opposition from market participants who have said that clearinghouses should have the option to decline risky or hard to value assets if they are put at risk of failing themselves.

“If central counterparties are forced to clear something they don’t feel comfortable with, we’d end up creating new systemic risk rather than reducing it,” said Kevin McPartland, senior analyst at TABB Group in New York.

Frank also said trading between financial institutions will need to be made on exchanges, without exemption. This rule would cover all banks that have traded with American International Group <AIG.N>, which he deemed “the poster child” of derivative problems.

AIG needed a government bailout out after selling hundreds of billions of dollars of protection on risky assets using CDSs.

Frank said he and House Agriculture Committee chairman Collin Peterson are very close to a deal to merge both panel’s bills.

SYSTEMIC RISKS Clearinghouses concentrate the exposures of large trading counterparties, and pose large risks to the financial system if they are undercapitalized.

Derivative contracts can be used to hedge against or bet on the changes in value of the underlying assets such as stocks, bonds, commodities.

Enforcing margin requirements on many derivatives, such as credit default swaps, can be challenging as the value of the contracts can rapidly change if a borrower is suddenly deemed near default. In some cases defaults can occur before sufficient collateral payments can be made.

“There’s a fairly significant risk that if a regulator decides they have to clear something and can set capital or otherwise determine how to appropriately clear a product, we have succeeded in just pushing risk to clearing corporations and raised the risk that they may not have adequate capital,” said Paul Forrester, partner at law firm Mayer Brown in Chicago.

“That’s a potentially larger problem than the one we’re trying to solve,” he said.

Executives at CME Group Inc and LCH.Clearnet, both of which plan to clear credit default swaps, have said they are wary of clearing contracts that trade infrequently or have few pricing sources. For details, see

Frank said he also requested the change in a letter to CFTC Chairman Gary Gensler. The full House still needs to vote on the bill, and the Senate must agree before president Barack Obama could sign it into law.

House Agriculture Committee passes bill

"The House Agriculture Committee approved legislation regulating over-the-counter derivatives after adopting a provision that may speed agreement on regulation of the $592 trillion industry.

The amendment by committee Chairman Collin Peterson would exempt end-users -- companies such as manufacturers and airlines that employ derivatives to hedge their operational risks -- from increased capital, trading and disclosure requirements.

“In crafting this bill, our target for greater regulation and oversight is not the end-user but their swap dealer or major swap participant counterparty,” Peterson, a Minnesota Democrat, said during debate on the bill. “End-users did not get a bailout of billions of dollars. End-users are not responsible for what happened in markets last year.”

The legislation was approved by voice vote. The House Financial Services Committee approved a bill on Oct. 15 with a similar exemption for end-users.

The Obama administration called in August for Congress to enact rules governing the over-the-counter derivatives market, saying a lack of transparency exacerbated the credit crisis and contributed to the near-failure of American International Group Inc.

Opaque financial products including derivatives have contributed to almost $1.6 trillion in writedowns and losses at the world’s biggest banks, brokers and insurers since the start of 2007, according to data compiled by Bloomberg.

Gensler’s Comment

Gary Gensler, chairman of the Commodity Futures Trading Commission, said in a speech in Chicago today that any exemption for end-users “should be very narrowly defined” to include only nonfinancial institutions.

Peterson said the legislation approved today wouldn’t open broad loopholes.

“Seventy to 80 percent of this stuff will be cleared,” Peterson told reporters after the committee met. “The clearinghouse will decide what gets cleared, not some government agency.”

Both bills in the House would set new margin and trading requirements for swaps dealers and “major swap participants.” Sponsors of the measure say that would apply the rules to the biggest users of derivatives, including hedge funds, AIG and mortgage-finance companies Fannie Mae and Freddie Mac.

“Our initial review is positive,” said David Schryver, executive vice president of the American Public Gas Association, a trade group representing small U.S. gas utilities. Without the exemption, he said his group’s members, which use derivatives to manage price and supply risks, would have to raise prices or limit use of the instruments.

Position Limits

The Agriculture Committee also adopted by voice vote a provision that would restrict the CFTC Commission’s power to set position limits for derivatives dealers.

The amendment would require the CFTC to develop position limits for “all economically equivalent contracts on all trading venues concurrently” and to impose those limits “with the intention to mitigate” the loss of trading on U.S. exchanges.

Giving regulators broad authority to set position limits, as the Agriculture Committee originally proposed, would result in a “flight of trading -- from the very type of transparent, responsible regulation the bill is trying to encourage to less transparent trading platforms,” said Representative Debbie Halvorson. The Illinois Democrat co-sponsored the provision with Representative Robert Goodlatte, a Virginia Republican.

‘Excessive’ Speculation

Gensler has said the CFTC has authority to limit “excessive” speculative trading in energy markets. He has asked Congress for the authority to also restrict commodity speculation in the over-the-counter derivatives market, where regulatory gaps allow traders to amass positions far larger than limits intended to keep one trader from gaining too much control.

Speculators include index- and exchange-traded funds and other traders that don’t take physical delivery of a commodity.

CME Group Inc., the world’s largest futures market, told U.S. lawmakers and regulators that business is already moving abroad because of potential trading limits under consideration by the commission.

Companies that offer derivatives investments, including Deutsche Bank AG, have shifted activity to markets outside the U.S. because of the proposed limits, Chicago-based CME said in a letter to Gensler dated yesterday.

House Financial Services Committee passes bill

"The House Financial Services Committee today approved legislation that would, for the first time ever, require the comprehensive regulation of the over-the-counter (OTC) derivatives marketplace. Today’s bill, which was approved by a vote of 43-26, represents a key part of a broader effort by Congress and President Obama to modernize America’s financial regulatory system in response to last year’s financial crisis.

Under the bill, all standardized swap transactions between dealers and large market participants, referred to as “major swap participants,” would have to be cleared and must be traded on an exchange or electronic platform. A major swap participant is defined as anyone that maintains a substantial net position in swaps, exclusive of hedging for commercial risk, or whose positions creates such significant exposure to others that it requires monitoring. OTC derivatives include swaps, which are contracts that call for an exchange of cash between two counterparties based on an underlying rate, index, credit event or the performance of an asset.

The legislation then sets out parallel regulatory frameworks for the regulation of swap markets, dealers, and major swap participants. Rulemaking authority is held jointly by the Commodity Futures Trading Commission (CFTC), which has jurisdiction over swaps, and the Securities and Exchange Commission (SEC), which has jurisdiction over security-based swaps. The Treasury Department is given the authority to issue final rules if the CFTC and SEC cannot decide on a joint approach within 180 days. Subsequent interpretations of rules must be agreed to jointly by the Commissions.

Description of the Over-the-Counter Derivatives Markets Act of 2009

Comparative analysis of the Treasury, Ag and Fin Serv versions

  • T = Treasury Proposal -- 08/11/09
  • F = Financial Services Com. Draft 10/02/09
  • A = Agriculture Com. Draft 10/09/09

Definitions of swap/security-based swap

T -- Excludes foreign exchange swaps and foreign exchange forwards from definition of swap, which exempts these transactions from the bill’s provisions

F -- Excludes foreign exchange swaps and foreign exchange forwards from definition of swap, which exempts these transactions from the bill’s provisions

A -- Includes foreign exchange in definition of swap and excludes foreign exchange forwards from definition only under certain conditions

Rulemaking

T -- Joint rulemaking between CFTC and SEC for almost all rules concerning swap/security-based swap-related provisions

F -- Joint rulemaking between CFTC and SEC for almost all rules concerning swap/security-based swap-related provisions

A -- CFTC consults with SEC and Prudential Regulators for rulemaking regarding swap-related provisions; SEC consults with CFTC and Prudential Regulators for rulemaking regarding security-based swap provisions

Rulemaking Disputes

T-- Treasury writes rules if CFTC/SEC cannot jointly agree to rules

F -- Treasury writes rules if CFTC/SEC cannot jointly agree to rules

A -- Either CFTC or SEC can initiate expedited challenge in U.S. Court of Appeals for DC of the other agency’s rules that encroach on its jurisdiction or allow for disparate treatment of economically similar products/participants

Mixed swaps

(i.e. swaps with security and commodity features)

T -- Dual regulation by both CFTC and SEC

F -- Dual regulation by both CFTC and SEC

A -- Preponderance test that assigns products to either CFTC or SEC regulation depending on what the swap is primarily based upon

Definition of swap dealer/security based swap dealer

T -- Person engaged in business of buying and selling swaps/security-based swaps for own account;

F -- Exception: not as a part of regular business Person engaged in business of buying and selling swaps/security-based swaps for own account;

A -- Exception: not as a part of regular business Person for whom significant part of business is holding itself out as dealer of swaps/security-based swaps, making markets, buying and selling to customers as ordinary course of business

Definition of major swap/security-based swap participant

T -- Non-swap dealer/non-security-based swap dealer who maintains a substantial net position of swaps/security-based swaps other than to create and maintain a hedge under GAAP

F -- Non-swap dealer/non-security-based swap dealer who maintains a substantial net position of swaps/security-based swaps, excluding those for hedging or risk management Regulators define substantial net position for effective monitoring of financial system

A -- Non-swap dealer/non-security-based swap dealer who maintains a substantial net position of non-cleared swaps/security-based swaps. Regulators define substantial net position for effective of entities which are systemically important or can significantly impact the financial system

Clearing requirement for swaps/security-based swaps

T -- Yes, derivative clearing organizations (DCOs)/clearing agencies and CFTC/SEC determine which swaps/security-based swaps must be cleared Requirement is retroactive

F -- Yes, CFTC/SEC determine which swaps/security-based swaps must be cleared Requirement is retroactive

A -- Yes, DCOs/clearing agencies determine which swaps/security-based swaps must be cleared Requirement is prospective

Clearing requirement determination

(Section needs clarification)

-- “Standardized” swaps/security-based swaps are required to be cleared
-- Swaps/security-based swaps accepted by DCOs/clearing agencies presumed “standardized”
-- Agency can designate a swap/security-based swap “standardized”

Agencies makes determination whether a swap/security-based swap must be cleared based on enumerated factors

Only swaps/security-based swaps that will be accepted by a DCO/clearing agency are required to be cleared

Agencies review DCO/clearing agency for safety/soundness, anti-competitive practices, risk management prior to application of clearing requirement

Clearing exceptions

T-- a) DCO/clearing agency won’t take swap/security-based swap, or b) one of counterparties

  • - is not a swap dealer/security-based swap dealer or major swap/security-based swap participant, and
  • - does not meet the eligibility requirements of DCO/clearing agency

F -- a) DCO/clearing agency won’t take swap/security-based swap, or b) one of counterparties is not a swap dealer/security-based swap dealer or major swap/security-based swap participant

A -- a) one of the counterparties:

  • - is not a swap dealer/security-based swap dealer or major swap/security-based swap participant, and
  • - can demonstrate appropriate business/risk management practices for non-cleared swaps /security-based swaps; and

b) none of the counterparties are a Tier 1 financial holding company

Trading Requirement

T -- Yes, swaps/security-based swaps determined to be cleared must also be traded on regulated exchange or alternative swap execution facility

F -- Rep. Frank (D., Mass.) introduced an amendment to the legislation Wednesday that would require all swaps that are standard enough to clear through a central counterparty to be traded on exchanges, so long as they are between financial institutions. Companies that use swaps to hedge interest-rate and commodity risks tied to their business would be exempt from trading on exchanges, unless its position was so large it caused a risk to its counterparties.

A -- Yes, swaps/security-based swaps determined to be cleared must also be traded on regulated exchange or alternative swap execution facility

Trading Exceptions

T -- None

F -- N/A

A -- a) Trading not required if no regulated exchange or alternative swap execution facility will list the swap, and b) Voice brokers still permitted to enter and execute swaps/security-based swaps subject to clearing requirement provided they process swap/security-based swap through regulated exchange or alternative swap execution facility

Capital requirements for swap dealer -- for a bank

(Capital requirements for swap dealer/security-based swap dealer or major swap/security-based swap participant who is also a bank)

T -- a) Established by Prudential Regulator b) greater than zero for cleared swaps/security-based swaps, c) higher for swaps/security-based swaps that are not cleared

F -- a) Established by Prudential Regulator b) greater than zero for cleared swaps/security-based swaps, c) higher for swaps/security-based swaps that are not cleared

A -- a) Established by Prudential Regulator b) Appropriate for the risk associated with non-cleared swaps/security-based swaps being held as an swap dealer/security-based swap dealer or major swap/security-based swap participant as determined by the respective regulator

Capital requirements for swap dealer -- NOT a bank

(Capital requirements for swap dealer/security-based swap dealer or major swap/security-based swap participant who is NOT a bank)

T-- a) Established by CFTC/SEC b) Requirements must be same or higher as for a swap dealer/security-based swap dealer or major swap/security-based swap participant who is a bank

F-- a) Established by CFTC/SEC b) Requirements must be same or higher as for a swap dealer/security-based swap dealer or major swap/security-based swap participant who is a bank

A- a) Established by CFTC/SEC b) Appropriate for the risk associated with the non-cleared swaps/security-based swaps being held as an swap dealer/security-based swap dealer or major swap/security-based swap participant as determined by the respective regulator

Margin requirements for non-cleared swaps - for a bank

(Margin requirements for non-cleared swaps/security-based swaps held swap dealer/security-based swap dealer or major swap/security-based swap participant who is also a bank)

T- a) Prudential Regulators impose initial and variation margin requirements on all swaps/security-based swaps b) Prudential Regulators may exempt requirements for swaps/security-based swaps where one of the counterparties is:

  • - not a swap dealer/security-based swap dealer or major swap/security-based swap participant,
  • - using the swap/security-based swap as hedge under GAAP
  • - predominantly engaged in activities that are not financial in nature

F -- a) Prudential Regulators impose initial and variation margin requirements on all swaps/security-based swaps b) Prudential Regulators may exempt requirements for swaps/security-based swaps where one of the counterparties is not a swap dealer/security-based swap dealer or major swap/security-based swap participant

A -- Prudential Regulators impose initial and variation margin requirements only for swap dealers/security-based swap dealers and major swap/security-based swap participants under their jurisdiction

Margin requirements for non-cleared swaps - NOT a bank

(Margin requirements for non-cleared swaps/security-based swaps held swap dealer/security-based swap dealer or major swap/security-based swap participant who is NOT a bank)

T -- a) CFTC/SEC impose initial and variation margin requirements b) Requirements must be same or higher as for a swap dealer/security-based swap dealer or major swap/security-based swap participant who is a bank

F -- a) CFTC/SEC impose initial and variation margin requirements b) Requirements must be same or higher as for a swap dealer/security-based swap dealer or major swap/security-based swap participant who is a bank c) Requirements must provide for use of non-case assets as collateral

A -- CFTC/SEC impose initial and variation margin requirements only for swap dealers/security-based swap dealers and major swap/security-based swap participants under their jurisdiction

Position Limits for swaps/security-based swaps

T -- a) CFTC/SEC may impose position limits on swaps/security-based swaps that perform a significant price discovery function a) CFTC/SEC may require aggregate limits across markets

F -- a) CFTC may impose position limits on swaps that perform a significant price discovery function and require aggregate limits across markets b) SEC may impose position limits on security-based swaps as necessary or appropriate in the public interest to prevent fraud and manipulation

A -- a) CFTC may impose position limits on swaps that perform a significant price discovery function and require aggregate limits across markets b) SEC may impose position limits on security-based swaps as necessary or appropriate in the public interest to prevent fraud and manipulation

Position Limits on Alternative Swap Execution Facilities (ASEF)

T - ASEFs shall adopt position limits where necessary and appropriate

F -- No position limit requirement for ASEFs

A-- ASEFs shall adopt position limits where necessary and appropriate

Addressing Excessive Speculation on Regulated Markets

T -- No provision

F -- No provision

A -- a) CFTC to set position limits on futures contracts for physically deliverable commodities on regulated markets (H.R. 977) b) Redefines who is eligible for hedge exemption and can exceed position limits (H.R. 977)

Foreign Board of Trade

T -- Allows CFTC to require registration by foreign boards of trade (FBOTs)

F -- Allows CFTC to require registration by FBOTs

A -- No explicit registration authority applied to FBOTs

Alston & Bird comparative analysis of the House legislation

Last Friday, Congressman Collin Peterson (D-MN), Chairman of the House Agriculture Committee, released a discussion draft of proposed legislation to strengthen the regulation of the over-the-counter (OTC) derivatives market. The proposed legislation largely reflects the principles outlined in the concept paper jointly released by Congressman Barney Frank (D-MA), Chairman of the House Financial Services Committee, and Congressman Peterson a few months ago, and attempts to reconcile the concerns raised at the hearings held by the House Agriculture Committee late last month. The House Agriculture Committee prepared a table comparing Congressman Peterson’s proposal, Congressman Frank’s discussion draft of proposed legislation circulated earlier this month, and the Obama administration’s proposal released in August. Key points from the table are summarized below.

For almost all rules concerning swap and security-based swap-related provisions, the Obama and Frank proposals provide joint rulemaking authority between the Commodity Futures Trading Commission and the Securities and Exchange Commission. When the CFTC and SEC cannot reach agreement, the Treasury Department would intercede and write rules. Congressman Peterson’s proposal allocates primary rulemaking authority to the CFTC with respect to swap-related provisions and to the SEC with respect to security-based swap provisions, though each agency would be required to consult with the other on the rules. Under the Peterson proposal, in the event that the CFTC and SEC disagree, either agency would be able to initiate an expedited action in the U.S. Court of Appeals for the District of Columbia to challenge the other agency’s rules “that encroach on the initiating agency’s jurisdiction or allow for disparate treatment of economically similar products or participants.”

Similar to the Obama administration’s proposal, Congressman Peterson’s draft legislation leaves it to derivatives clearing organizations (DCOs) and clearing agencies to determine which swaps would require clearing. Swaps that have been accepted by a DCO or clearing agency would be required to be cleared under Congressman Peterson’s proposal, unless (i) one of the counterparties is not a swap dealer or major swap participant and can demonstrate appropriate business and risk management practices for non-cleared swaps and security-based swaps and (ii) neither counterparty is a Tier 1 financial holding company. Congressman Frank’s proposal would allow the CFTC and the SEC to jointly determine which products must be cleared, based on enumerated factors.

Congressman Peterson would subject foreign exchange swaps to the requirements of the legislation, but would exclude foreign exchange forwards in some circumstances. The Obama administration’s proposal and Congressman Frank’s proposal would exclude both foreign exchange swaps and foreign exchange forwards from the legislative requirements.

The Obama proposal requires that all cleared swaps be traded on regulated exchanges or alternative swap execution facilities with no exceptions. The Frank proposal provides no mandatory trading requirement for cleared swaps. The Peterson proposal does not require that cleared swaps be traded on regulated exchanges or alternative swap execution facilities if no such exchange or execution facility will list the swap. Unlike the other two proposals, the Peterson proposal does not impose higher capital requirements on swap dealers or major swap participants for non-cleared swaps, but rather authorizes regulators to determine appropriate capital requirements for such dealers or participants based upon the risk associated with such non-cleared swaps.

The proposals are aligned on the issue of setting position limits for swaps. All of the proposals authorize the CFTC and SEC to impose position limits on swaps and security-based swaps that “perform significant price discovery functions” and in order to “prevent fraud and manipulation.” The agencies are also authorized to require aggregate position limits across markets under each proposal.

Media coverage of Fin Serv and Ag convergence work

"...The best aspect of the House bill is that it requires many swaps to be traded on exchanges just like stocks, subjecting them for the first time to the light of day. But elsewhere in the bill, known as the Over-the-Counter Derivatives Market Act of 2009, exceptions to this exchange-trading rule undermine its regulatory power.

Derivatives regulation has been on the nation’s financial reform agenda for months. Undoing the Clinton-era law that exempted swaps from oversight is seen as imperative, except perhaps by big banks that deal in the contracts. It’s worth noting that many members of the Clinton economic team, including Lawrence Summers, Timothy Geithner and Gary Gensler, now hold pivotal policy-making positions in the Obama administration.

In August, the White House sent its derivatives proposal to Congress, recommending that all standardized contracts trade on an exchange. But big banks dealing in swaps don’t want exchange trading, where pricing and the identities of participants would be more publicly transparent. Savvier swaps customers would soon pay less on their transactions and bank profits would fall.

Some swaps buyers also dislike exchange trading because it would require them to put up a cash cushion — or margin — before a transaction. This is to help prevent counterparty failures, but participants in the market prefer not to pay this freight. They’d rather taxpayers foot the bill for a possible collapse later on, as they did with A.I.G.

Representative Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee, dismissed criticism of the bill he is steering along, saying that it would create incentives to make exchange-traded swaps the norm. “We passed the bill to drive most of the swaps onto exchanges,” he said in an interview Friday. “End users will move in that direction to save money.” But Michael Greenberger, a University of Maryland law professor and an expert in derivatives, criticized the House bill. “While I know there was a good-faith effort to improve the regulation, the plain language of the legislation can only be read as a Christmas tree of decorative gifts to the banking industry,” he said. “And this is being done when people acknowledge the unregulated O.T.C. derivatives market was a principal reason for the meltdown.”

A SIGNIFICANT exception in the bill says that if a transaction involves a company that uses a swap to offset its commercial risks — the bill defines this entity as an end user — its trade does not have to be put on an exchange. This was intended to address complaints from swaps customers — like airlines or oil companies that hedge their commercial risks — that their costs would rise unnecessarily under the bill.

"Two little-noticed amendments inserted Wednesday into legislation seeking to strengthen regulation of derivatives will allow private industry to continue to set rules and largely self-regulate, tying the hands of regulators who want more say in how these exotic financial instruments are traded.

Offered by Rep. Judy Biggert, an Illinois Republican, the provisions take away power the Obama administration proposed giving to the Commodity Futures Trading Commission (CFTC), the regulator in charge of policing most types of derivatives. Rather, the power to supervise how derivatives are traded will rest with the clearinghouses and exchanges that house them. Furthermore, when the exchanges and clearinghouses change or offer up new rules, the CFTC will not be able to review them before they are finalized to ensure, for example, that they comply with existing law. Instead, the rules proposed by private industry will immediately go into effect.

These powers, which the CFTC has lacked since a major deregulatory law was passed in the waning days of President Bill Clinton's final term, would enable the CFTC to exert the kind of authority many have criticized the agency for not using. Unregulated derivatives trading by the likes of AIG and Lehman Brothers nearly caused the collapse of the global financial system.

Biggert's amendments were quickly adopted by the House Financial Services Committee without debate. Committee Chairman Barney Frank, who has repeatedly promised meaningful reform, punted the issue to the House Agriculture Committee which is handling a separate yet similar bill. Derivatives reform legislation passed Financial Services on Thursday morning. Biggert was not available for comment. A spokesman for Frank said the issues the provisions addressed should be handled by the agriculture committee, and that Biggert's amendments "were accepted to move the debate along."

"It's a return to the regulatory environment that led us into the meltdown," said Michael Greenberger, a professor at the University of Maryland Law School and former director of trading and markets at the CFTC. "It would tie the hands of effective regulation by the CFTC to the detriment of economic recovery. The [Obama] administration had it completely right in its proposal."


"The crucial details of derivatives reform remain elusive.

IF YOU thought derivatives were hideously complex, try following the battle to regulate them. The Obama administration's reform blueprint, which was released in August, foreshadowed a huge shake-up to the over-the-counter (OTC) derivatives market.

All "standardised" OTC derivatives would be cleared and traded on an exchange, and even large industrial firms would incur stricter margining and capital charges on their trades.

Now the House Committees on Financial Services and on Agriculture, each responsible for derivatives oversight, have released diluted proposals of their own.

Fewer firms would be covered by margining and capital requirements, and fewer derivatives would be cleared by a central counterparty or traded on exchanges.

Most of the differences hinge on the definition of a "major swap participant". No one disputes that big banks should observe tighter rules for derivatives trading, but should oil companies, airlines and fund managers, which routinely use derivatives for hedging, face more regulation too? The stakes are high.

In the interest-rate and foreign-exchange markets alone, non-financial firms account for about $50 trillion of derivatives outstanding. Earlier this month over 170 firms, including Ford, Shell and Procter & Gamble, wrote a letter to lawmakers bemoaning the "extraordinary burden" they would face if they had to join clearing houses or allocate their precious cash reserves to margin payments.

The latest congressional proposals leave much to be clarified. The Securities and Exchange Commission (SEC) frets that looser rules will let key derivative traders, such as hedge funds, off the hook. Many non-financial firms hold derivative positions far in excess of their hedging needs.

The House plans exclude firms that are not "systemically important" or do not expose their counterparties to "significant credit losses". But as Kevin McPartland of TABB Group, a research firm, points out: "A few years ago AIG would not have been considered systemically important."

There are two other big points of contention. The lawmakers have watered down the concept of standardised OTC derivatives. The Treasury wanted central counterparties to clear as many OTC derivatives as they could. The committees' proposals give the SEC and the Commodity Futures Trading Commission (CFTC) more discretion to decide what gets cleared.

Whether cleared OTC derivatives should be traded on an exchange is the other big debating point. The Treasury believes banks dislike exchange-trading platforms because they narrow bid-ask spreads, undermining profitability. Others argue that few OTC derivatives markets are amenable to exchange-trading anyway.

"Companies use OTC derivatives like we buy complex holidays from a travel agent," says Christopher Ferreri of the Wholesale Markets Brokers' Association, an industry body. "Everyone's holiday is different and the buyer wants one quoted price." The Committee on Financial Services removed the exchange-trading requirement (but may backtrack); the Agriculture Committee diluted the definition of an exchange.

All three proposals maintain the cumbersome supervisory split between the SEC and the CFTC. The SEC would regulate derivatives tied to individual securities, and the CFTC much of the rest. This, for instance, leaves CDSs for a single company within the SEC's purview, but those for an index of many companies with the CFTC. The Treasury hopes the House will have passed a combined bill by the end of November. That just leaves the Senate.

"The House Financial Services Committee's leadership moved to alter its bill to regulate derivatives, mandating that some derivative contracts trade on exchanges, a switch from a position it staked out late last week.

The change in the form of an amendment from Barney Frank, chairman of the committee, moves the bill closer to legislation proposed by the House Agriculture Committee and Obama administration, but it drew criticism from several Republican members.

The House is at the beginning of the legislative process to enact the Obama administration's proposed financial regulation overhaul. A vote on the derivatives bill and its amendments is expected Thursday morning. The House committee is expected to debate a provision to create a new agency to regulate financial products sold to customers Thursday and Friday.

Rep. Frank (D., Mass.) introduced an amendment to the legislation Wednesday that would require all swaps that are standard enough to clear through a central counterparty to be traded on exchanges, so long as they are between financial institutions.

Companies that use swaps to hedge interest-rate and commodity risks tied to their business would be exempt from trading on exchanges, unless its position was so large it caused a risk to its counterparties.

The move bows to arguments from the Treasury Department and Commodity Futures Trading Commission that derivatives should be traded on exchanges to reduce systemic risk and increase price transparency. The original version of the bill introduced late last week only required swaps be cleared through a central counterparty, but didn't mandate trading on an exchange or electronic equivalent.

Rep Frank's change in position surprised Republicans and others. He didn't offer an explanation for the amendment other than to suggest that his thinking has been fluid. Mr. Frank said he initially supported exchange trading and then was "persuaded by conversations with end users" against it.

Now, he said, he was at a point he "felt comfortable" with the bill. "Watching sausage being made isn't always attractive. It is clearly the case there has been a lot of give and take," Frank said.

Rep. Scott Garrett (R., N.J.) objected to the amendment, stating that the bill was "moving until last night to clearing house arrangement. This goes 180 degrees in the absolute other direction." Rep. Garrett and other Republicans said putting derivatives onto exchanges isn't the only way to bring transparency to the market.

Rep. Frank agreed but noted, "We are dealing with the kind of activity that is both in the interest of the individual and has systemic impact."

The committee also grappled with several other amendments to the bill, including repealing a section that would give regulators authority to ban certain types of swaps.

The bill will have to be reconciled with draft legislation under consideration with the House Agriculture Committee before it would go to the full House for a vote. The Senate is less advanced in its discussions to regulate derivatives so the timetable for when a bill could be signed into law is sliding."


As President Barack Obama vowed in a Sept. 14 speech in New York’s Federal Hall to correct “reckless behavior and unchecked excess” on Wall Street, Mike McMahon and Barney Frank sat in the audience discussing how to ease proposed rules for the $592 trillion over-the-counter derivatives market.

Side by side at 26 Wall St., across from the New York Stock Exchange, freshman congressman McMahon told House Financial Services Committee Chairman Frank he was worried that Obama’s derivatives plan, released in August, would penalize a wide swath of U.S. corporations and could push jobs in his home district overseas, McMahon said in an interview.

“It’s not just the farmers, and it’s not just the Wall Street guys,” said McMahon, a member of the New Democrat Coalition, a group of 68 self-described pro-growth Democrats in the U.S. House of Representatives. “It’s across the nation. American industry uses these products for a very useful purpose, which keeps down prices and makes consumer products cheaper.”

McMahon said Frank agreed it was important to protect so- called end-users, the corporations that rely on derivatives to hedge everyday operational risk, such as fluctuations in foreign currency rates, interest rates and commodity prices. The Obama plan would subject companies to higher collateral requirements whether they trade standardized or customized contracts. It also calls for most trades to be executed on an exchange or an “alternative swap execution facility.”

“He said we’d be working together on this,” said McMahon, who represents a large constituency of Wall Street workers on Staten Island and in southwest Brooklyn. “We never had a philosophical difference.”

It’s not just end-users who won concessions from McMahon and Frank. JPMorgan Chase & Co.,Goldman Sachs Group Inc. and Credit Suisse Group AG lobbied McMahon and fellow New Democrat Coalition member Representative Melissa Bean of Illinois, among others, to expand the ways the legislation allows dealers and major investors to trade the contracts, according to people familiar with the matter.

Bean’s spokesman Jonathan Lipman rejected the notion that the New Democrats made any changes to the bill at the behest of banks.

“New Dems have promoted strong regulatory reform that institutes trade and price reporting, capital requirements, and margin requirements, all of which puts mandates on these institutions that they don’t like,” Lipman said. “New Dems have been focused on increasing transparency, reducing systemic risk, and preserving the ability for end-users to hedge their risk.”

JPMorgan spokesman Justin Perras, Goldman Sachs spokesman Michael DuVally and Credit Suisse spokeswoman Victoria Harmon declined to comment.

The battle over derivatives legislation is a test for the Obama administration’s efforts to tighten financial regulation to prevent a repeat of the financial crisis that shook the global economy -- a crisis exacerbated by derivatives trading.

Frank, a Massachusetts Democrat who rose through the ranks in Congress fighting homelessness and advocating for gay and consumer rights, found his handiwork panned by administration officials after he released draft legislation last week that they criticized as too friendly to business. Frank’s bill allows for no change in how standardized over-the-counter derivatives are traded as long as they are reported to regulators.

Commodity Futures Trading Commission Chairman Gary Gensler and Henry T.C. Hu of the Securities and Exchange Commission said Frank’s “discussion draft” created too many loopholes and had the potential to exclude all hedge funds and corporate end-users from oversight.

“That’s why it’s called a discussion draft, because it brings forth people’s comments,” Frank said in an interview after an Oct. 7 hearing at which Gensler and Hu testified. “It’s an ongoing process.”

Frank told the committee that he agreed to “tighten up” the legislation before it is voted on next week.

With 68 of the Democrats’ 256 votes in the House, the New Democrats have become a growing force within their party. Democrats hold a 38-member voting majority over Republicans and cannot pass financial legislation without coalition support.

“Oh, they were very important,” Frank said. “A couple of them have some experience in this area. They are also an important part of our caucus.”

Derivatives dealers became concerned that Obama’s plan didn’t adequately define “alternative swap execution facility” and that, in the end, regulators would write rules making them similar to exchanges, people familiar with the lobbying effort said. Over the last two months, the banks pressed to have Frank’s draft allow standardized trades to be executed privately via telephone, as they’ve been traded for decades, as long as they are reported to regulators, the people said.

The change could protect billions of dollars in profit for the dealers. When securities or derivatives are traded on exchanges -- where investors can see real-time prices, rather than indicative prices sent by e-mail in the over-the-counter market -- it can shrink the amount that dealers make on each trade, known as the spread.

“Having more discretion for the dealers in the regulations gives an extra benefit to them by staying away from narrower spreads,” said Darrell Duffie, a finance professor at Stanford University in California.

The top five U.S. commercial banks, including JPMorgan, Goldman Sachs and Bank of America Corp., were on track through the second quarter to earn more than $35 billion this year trading unregulated derivative contracts, according to a review of company filings with the Federal Reserve and people familiar with the banks’ income sources.

The banks are arguing that an exchange or trading-system mandate that publicizes large trades could make it too expensive or impossible to execute customer orders and hedge those trades at the same time, according to the people familiar. Publicized large orders may dry up the willingness of dealers and investors to buy or sell contracts, they said.

That argument might not get a sympathetic ear at the Commodity Futures Trading Commission. Its chairman has several times called the regulated platforms “electronic trading systems,” suggesting that U.S. officials may seek to require banks and investors to use them like exchanges with real-time, public pricing.

“People viewed it as tantamount to an exchange,” said Robert Pickel, chief executive officer of the International Swaps and Derivatives Association, a New York-based group that sets standards in OTC derivatives markets.

While the concerns were raised through both Republicans and Democrats, “the New Democrats have played a central role here both in terms of interacting with the end-users but also being able to take that concern to Chairman Frank,” Pickel said.

A half dozen New Democrats pressed Treasury Secretary Timothy Geithner to expand the administration’s exemption for end-users in an Oct. 1 meeting.

“We got into the weeds on the derivatives bill,” said Connecticut Representative James Himes, a former investment banker at Goldman Sachs and a member of the New Democrats, who attended the meeting along with McMahon, Bean and chairman Joseph Crowley of New York.

Unlike Obama’s plan, Frank’s bill doesn’t require derivatives users or dealers to execute standardized over-the- counter contracts on a regulated exchange or trading platform, which would force greater price transparency. Instead, it gives them the option to decide if they want to use an exchange or a trading platform, or merely report the transaction to regulators by the end of the day.

Not mandating exchange or other types of electronic trading “will probably prevent spreads from dropping like a rock,” said Kevin McPartland, a senior analyst in New York at Tabb Group, a financial-market research and advisory firm. “There’s no reason, at least that I can see, why anybody would go to an exchange.”

The legislation “recognizes that a lot of derivatives contracts are non-standardized, meaning that IBM has exposure to the yen on a certain timetable that just doesn’t fit into standard exchange-traded contract,” said Himes. “The bill recognizes that some risks are unique. Sometimes you need a custom-made contract that won’t be exchange-traded or clearinghouse-cleared.”

Executives and lobbyists in finance, manufacturing, agriculture and other industries had been pressing lawmakers and administration officials for months before McMahon’s fortuitous seating assignment at Federal Hall.

“We’ve seen a steady parade of all of the big dealers, all of the major money-center banks have come through Congress,” Himes said in an interview.

The House Agriculture Committee approved legislation in February granting the CFTC or SEC oversight of clearinghouses backing credit-default swaps. It also would have allowed those regulators to suspend trading in the $26 trillion market.

“That acted as a catalyst, and we formed a small group of companies that were interested in this issue,” said Dorothy Coleman, vice president of tax and domestic economic policy at the National Association of Manufacturers in Washington. Momentum continued to build over the next six months as the Obama administration made derivatives reform a key element of its financial regulatory agenda.

The NAM group was joined by members of the U.S. Chamber of Commerce and the Business Roundtable to form the Coalition for Derivatives End-Users. Its 171 members are all non-financial corporations, including brewer MillerCoors LLC, International Business Machines Corp. and tractor-maker Deere & Co.

The coalition sent Congress a letter on Oct. 2 saying that some reform proposals “place an extraordinary burden on end- users of derivatives.” Members also met this week with lawmakers and staff on Capitol Hill.

In the end-users coalition, broker-dealers found a powerful ally. Although the two groups say they didn’t coordinate their lobbying, their interests overlapped and many of the concessions won in the bill for end-users ended up benefiting some of the biggest Wall Street banks whose credit-default swaps exacerbated the financial crisis.

“There’s very little sympathy for the plight of money-center banks on Capitol Hill right now,” Himes said.

Joint House Committee concept paper for OTC derivatives legislation

Source: Chairmen Peterson and Frank's "Description of Principles for OTC Derivatives Legislation" July 30, 2009

Chairman Peterson said: “I am pleased that Chairman Frank and I were able to come to agreement on so many principles with regard to OTC derivatives reform. I think we have come up with a responsible approach that bridges the differences between those members who want to completely eliminate the over-the-counter market and those who think that just greater transparency is all that is needed. Neither of those approaches is a real solution; what we are putting forth is.

“Putting this concept paper out now will give members of both Committees plenty of time to review it, develop ideas, suggestions, thoughts and comments so everyone will be prepared to tackle these issues when we return in September. I look forward to working with Chairman Frank so we can enact legislation that gives the American people the confidence that our markets are being overseen and monitored by strong, effective regulators.”

Chairman Frank said: “The fundamental purpose here is to improve the regulation of derivatives so that they continue to perform their important market function but are less likely to contribute to a kind of irresponsibility that can cause a crisis. Nobody here wants to ban them or even severely diminish them as an economic instrument. The Committee on Agriculture represents a lot of end users for whom they are very important. The Committee on Financial Services deals with a lot of the financial institutions. They have an interest that has to be blended. I thank Chairman Peterson and his staff for their cooperation on this effort.”

Robust Oversight of Dealers and Markets

Depending on the underlying asset on which a derivative is based, either the SEC or the CFTC, or potentially both, will oversee the regulation of OTC derivative dealers, exchanges and clearinghouses.

    • Clearinghouse Regulation: Clearinghouses will be robustly regulated. Primary oversight authority of the CDS clearinghouse, ICE Trust, will be shifted from the Federal Reserve to a market regulator after a period not longer than six months from the date of enactment.
    • Trade Reporting: All OTC derivative trades must be reported to a qualified trade repository.
    • Regulatory Approval: Requests for approval as a clearinghouse, exchange or electronic trading platform must be acted on by the relative agency within 180 days.
    • Regulatory Harmonization: The statutory and regulatory powers of the SEC and CFTC shall be harmonized with respect to the OTC derivative market including registration requirements for dealers.

Mandatory Clearing of OTC Derivatives

Derivatives must be cleared by an approved clearinghouse. Exchange trading and trading on electronic trading platforms will be strongly incentivized and encouraged.

Exceptions:

    • Appropriate regulator determines the product is not sufficiently standardized to be cleared or no qualified clearing mechanism exists.
    • One party in the transaction does not qualify as a “major market participant” as determined by the appropriate regulator in consultation with the Financial Services Oversight Council.

Regulators should have:

    • Authority to prohibit or regulate transactions that are not traded on exchange or cleared.

Strengthening Capital and Margin Requirements

  • Appropriate regulators will develop margin and capital requirements that create a strong incentive for dealers and users of derivatives to trade them on an exchange or electronic trading platform or have them cleared whenever possible.
  • Significantly higher capital and margin charges will apply to non-standardized transactions that are not exchange-traded or centrally cleared.
  • Regulators can authorize use of non-cash collateral to satisfy margin requirements.

Particular Attention to Speculation

At least two options will be considered:

1. Limitation on Speculation

Prohibition on any purchase of credit protection using a CDS contracts unless:

    • The party owns the referenced security or (one or more) of the securities in an index of securities.
    • The party has a bona fide economic interest that will be protected by the contract.
    • The party is a bona fide market maker.
    • Regulators will have authority to monitor market activity and impose position limit where necessary.

2. Enhanced Oversight of Speculative Positions

Require confidential reporting to the appropriate regulator of all short interest in CDS contracts by:

  • OTC derivatives dealers;
  • Investment advisers that manages in excess of $100 million;
  • Other entities that are deemed “major market participants”.

In order to prevent abuse, the appropriate regulator has authority to:

  • Impose position limits on market participants;
  • Ban the purchase of credit protection using CDS by any non-dealer that is not hedging a risk.

Protect U.S. Financial Institutions from Lesser Regulatory Standards in Other Countries

  • U.S. regulators will coordinate with foreign regulators on harmonizing OTC derivative market regulation including recognized international standards with respect to clearinghouses.
  • The Treasury Department will be authorized to restrict access to the U.S. banking system for institutions of any jurisdiction Treasury finds permits capital-related standards that are lower than the United States or that promote reckless market activity.

Role of Financial Services Oversight Council

  • Resolve disputes between the SEC and CFTC over authority over new products within 180 days.
  • Resolve disputes between the SEC and CFTC over joint regulation of derivative products within 180 days.

Enforcement

  • Agencies shall have enforcement authority over products under their jurisdiction.
  • Agencies shall hold enforcement authority jointly for any products subject to joint jurisdiction.

House Financial Services Committee hearing October 7

Watch archived video of hearing here.

Witnesses:

  • The Honorable Gary Gensler, Chairman, Commodity Futures Trading Commission
  • Mr. Henry Hu, Director, Division of Risk, Strategy, and Financial Innovation, U.S. Securities and Exchange Commission
  • Mr. Jon Hixson, Director, Federal Government Relations, Cargill Inc.
  • Mr. René M. Stulz, Everett D. Reese Chair of Banking and Monetary Economics, Fisher College of Business, The Ohio State University
  • Mr. Scott Sleyster, CFA, Chief Investment Officer, Domestic, Prudential Financial
  • Mr. David Hall, Chief Operating Officer, Chatham Financial Corp.
  • Mr. James J. Hill, Managing Director, Morgan Stanley on behalf of SIFMA
  • Mr. Stuart J. Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association
  • Mr. Steven A. Holmes, Director of Treasury Operations, Treasury Department, Deere & Company World Headquarters
  • Mr. Christopher Ferreri, Managing Director, ICAP on behalf of the Wholesale Markets Brokers Association
  • Mr. Rob Johnson, Director of Economic Policy for the Roosevelt Institute in New York on behalf of Americans for Financial Reform

Bloomberg) -- Legislation by Representative Barney Frank to tighten derivatives regulation contains an exemption that may let most financial firms escape new collateral and disclosure rules, the head of the Commodity Futures Trading Commission said.

The provision is among several loopholes in the draft legislation, officials of the CFTC and Securities and Exchange Commission said in testimony yesterday before the House Financial Services Committee headed by Frank.

The Massachusetts Democrat said he would “sharpen” his plan, intended to rein in the $592 trillion over-the-counter derivatives market. The committee has scheduled votes on it beginning Oct. 14. Frank predicted the legislation would pass the House by November and be signed into law by December.

A plan offered by the Obama administration would subject all swaps dealers and “major market participants” to new regulations for capital, business conduct, record-keeping and reporting. Frank’s version would exempt corporations from that definition if they use derivatives for “risk management” purposes.

While Frank’s proposal is a “step in the right direction,” its “ambiguous” definition of risk management may leave a large number of corporations unregulated, Henry T.C. Hu, director of the SEC’s new division of risk, strategy and financial innovation, told the committee.

“As just about all swaps could be defined as being used for risk management purposes, we’re concerned that unintentionally the category of ‘major swap participant’ could have been narrowed so significantly, or even to a null set,” CFTC Chairman Gary Gensler told reporters after the hearing.

“Major hedge funds” may be excluded from oversight, as may the mortgage-finance companies Fannie Mae and Freddie Mac “because of course the government-supported enterprises use swaps for risk management purposes,” Gensler said.

Frank should eliminate the “risk management” exclusion altogether, Gensler said.

“I agree it needs to be sharpened,” Frank said in a telephone interview yesterday. “I don’t think what he says is accurate, but my view is why take the chance? So we agree with him as to the concepts and we’ll make the language very clear.”

Gensler, who has previously asked Congress to strengthen, not weaken, the derivatives proposal the administration offered in August, also said Frank’s legislation shouldn’t let hedge funds or financial firms evade requirements that their derivatives contracts go through central clearinghouses.

The Frank proposal has drawn praise from business groups including the National Association of Manufacturers and the Securities Industry and Financial Markets Association. James Hill, a Morgan Stanley managing director who testified on behalf of the association, said in his testimony that the draft bill “includes many significant improvements” over the administration’s proposal.

Derivatives are contracts corporations use to hedge against risks such as swings in stocks, currencies, commodities and interest rates. Critics say Frank’s plan would do too little to curb abuses of the instruments that helped speed the downfall of American International Group Inc. and exacerbate the credit crisis over the last 18 months.

“It is clearly the weakest of all the proposals I’ve seen to date,” said Christopher Whalen, managing director of Institutional Risk Analytics in Torrance, California, in an interview before the hearing. Whalen, who has testified before Congress on derivatives regulation, is an independent bank analyst. “Frank’s committee seems to be intent on gutting any meaningful reform.”

Easing Requirements

The draft would ease trading and clearing requirements for derivatives dealers such as Morgan Stanley and Goldman Sachs Group Inc., compared with the administration’s proposal.

The administration’s plan would force all standardized derivatives transactions to be executed on an exchange or processed through a regulated clearinghouse, which impose collateral and margin requirements on trades. Frank’s bill wouldn’t move as many trades to exchanges.

Representatives Judy Biggert, an Illinois Republican, and Mel Watt, a North Carolina Democrat, criticized the bill at the hearing for being too lax.

Watt said the measure “created a loophole that’s way, way, way too big for major swaps dealers and major swaps participants.” Biggert said the draft “has some troubling things in its current form.”

Trade Repository

Frank’s bill would permit so-called non-standard contracts to be reported to a trade repository, which wouldn’t require companies to post collateral, instead of being processed through a clearinghouse.

It also differs from Obama’s plan in allowing regulators to decide which transactions need to be cleared, instead of giving clearinghouses that power.

Frank’s measure would give Cargill Inc., John Deere Capital Corp., Apple Inc. and other so-called end-users -- companies that hedge operational risks with derivatives -- an exemption from many new collateral and disclosure requirements for over- the-counter derivatives contracts. Those are privately negotiated deals that aren’t traded on exchanges.

The draft was crafted in part to win support from the New Democrat Coalition, which describes itself as moderate and “pro-growth.” Representative Mike McMahon, a New York Democrat and a member of the group, led in negotiating changes to the bill to ease requirements he said could have hampered the industry.

“With derivatives, a lot of people think it’s about speculation, but it’s about good American companies hedging their risks so they can be vibrant and competitive in the world market,” McMahon said in a telephone interview.

Financial District

The lawmaker, who represents Staten Island and southwest Brooklyn in New York, said the changes will also help preserve jobs on Wall Street.

“There are 80,000 people in my district who get up every day and go to work by ferry or subway or bus to the Financial District,” he said. “I want to make sure their jobs aren’t lost or eliminated or sent overseas.”


"Two federal regulators criticized parts of Rep. Barney Frank's proposal to overhaul financial regulation, saying it will let large companies escape restrictions on the types of financial products that contributed to last year's crisis.

Wall Street firms have pressed Mr. Frank, chairman of the House Financial Services Committee, to tone down the Obama administration's plan to have all "standard" derivative products trade on regulated exchanges or electronic platforms. The firms say that would hurt companies by making it harder to manage risk with tailored financial products such as contracts tied to the future price of energy or crops.

Nodding to the concerns, Mr. Frank's draft legislation eliminates mandates for trading on exchanges or equivalents. It also narrows the kinds of trades that would have to pass through a central clearinghouse.

Gary Gensler, chairman of the Commodity Futures Trading Commission, told a meeting of the committee that Mr. Frank has made the bill too lax on financial firms. He cited a provision allowing major companies that trade swaps to escape new regulations if they are making the trades to manage business risk.

Any exception "should be very narrowly defined," Mr. Gensler said in prepared remarks. Henry Hu, director of a new risk-management division at the Securities and Exchange Commission, added: "This wording could cause a large number of important entities to fall outside this needed new regulation."

Among the key entities that could escape regulation, Mr. Gensler later added, are government-sponsored enterprises such as housing-finance companies Fannie Mae and Freddie Mac, which were at the center of the financial crisis.

"I think this is an unintended consequence," Mr. Gensler told lawmakers. "We think it should be addressed."

Mr. Frank defended his proposal but added that it is still a "work in progress" and that he expects it to evolve. He said the bill must be sensitive to the needs of those who need derivatives to hedge risk and don't pose major threats to the financial system. He said he hopes to have the House vote on the bill by November.

Financial institutions say certain types of contracts may not be traded widely enough to justify trading on exchanges or equivalent markets.

Republicans called Mr. Frank's bill a step in the right direction. "When viewed in the context of the proposal that had been previously put forward by the administration on derivatives, Chairman Frank's discussion draft is an improvement in some respects," said Rep. Scott Garrett (R., N.J.).

Mr. Frank's draft bill still contains some of the main elements of the Obama plan. It calls for requiring the use of clearinghouses, which guarantee trades and reduce credit risk, for standardized contracts traded by dealer firms and major market players. It also would require all derivative trades to be reported to a central repository so regulators and the public can get more information on pricing. Under the plan, the SEC and CFTC would share authority to police the over-the-counter market.


WASHINGTON — A Securities and Exchange Commission official asked a congressional committee yesterday to strengthen its draft bill to regulate over-the-counter derivatives so that all securities-based swaps are treated as securities. However, the request was met by resistance from the panel’s chairman and another regulator.

Henry Hu, director of the SEC’s division of risk, strategy, and financial innovation, warned the House Financial Services Committee that its proposed derivatives bill would provide opportunities for “gaming” the regulatory system because the Commodity Futures Trading Commission would regulate swaps based on a broad-based index of securities while the SEC would only oversee swaps based on a narrow-based index of securities.

His remarks came after the committee released a “discussion draft” of a bill last week that calls for such a distinction, mirroring the proposal the Obama administration made earlier this year.

Both bills would authorize the CFTC to regulate swaps in the muni market that are based on the Securities Industry and Financial Markets Association’s bond index, which is broad-based.

Hu said the distinction makes little sense in light of the “arbitrage possibilities” that could allow a market participant to use a broad-based swap “to gain highly targeted exposure to a single company or a narrow group of companies.”

“Simplifying things, to treat for instance all securities-based swaps as securities, and falling within the parameters of the federal securities laws ... reduces the possibility of gaming, gaps, and facilitates more efficient responses,” he said.

In written testimony, Hu said the SEC’s concerns are compounded if security-based swaps are not considered securities under both the Securities Act of 1933 and the Securities Exchange Act of 1934. While the draft legislation revises the 1933 act to include “security-based swaps” in the definition of “security,” it does not make a corresponding change in the 1934 act, he said.

But Hu’s push for a “simplified” system was subtly rejected by both Gary Gensler, the CFTC chairman who testified on the same panel, as well as chairman Barney Frank, D-Mass.

“We think that the administration’s proposal and the discussion draft got this right and ... kept in line the 27-year arrangement where broad-based indices and futures ... are regulated by one market regulator” — the CFTC — “and narrow-based by the SEC,” Gensler said, referring to the Shad-Johnson Accord of 1982. The accord signed by then-SEC chairman John Shad and then-CFTC chairman Phillip Johnson outlined the commissions’ jurisdiction over futures.

Hu tried to respond, but Frank said there was not enough time. “There’s an interagency issue here, and we will have to move on,” he said. “I will have to tell the SEC that you are up against a pretty high hill if you’ve got the administration and the agriculture committee on one side.”

In his opening remarks, Frank said the draft bill “will and should undergo significant change” before it is voted on possibly later this month, though he was not referring to any specific provisions. He added that it could be signed into law by President Obama in December, though he conceded that assumes “the most ambitious timetable.”

One lawmaker said he believed the SEC should have increased oversight over securities-based swaps, particularly those that are entered into by municipalities.

Rep. Dennis Moore, D-Kan., said: “There are some items related to municipal swaps that should clearly remain under the jurisdiction of the SEC in order to be covered by the increased protections for muni securities and advisers that are coming under the SEC and other parts of regulatory reform.”

Moore also asked the panelists for their thoughts about “the unique nature of municipal finance that often require [issuer] contracts to be more customized.”

Hu did not directly respond to the request, but said that municipalities most directly relate to the legislation “in the area of business conduct.”

“One of the areas that we think may be appropriate would be in fact enhancing the business conduct requirements with respect to less sophisticated participants, some of whom may be municipalities,” Hu said. “We have real concerns about that. We’ve seen issues involving municipalities and their derivative activities that concern us.”

He also called for Congress to consider “raising the qualification standards for a governmental entity or political subdivision — such as a municipal government — to qualify as an ECP,” or eligible contract participant for OTC derivatives.


House Agriculture Committee hearing September 22

RE: To review proposed legislation by the U.S. Department of Treasury regarding the regulation of over-the-counter derivatives markets, part one.


Media coverage

House Agriculture Committee hearing September 17

House Agriculture Committee hearing September 17, 2009

10:30 a.m. 1300 Longworth House Office Building, Full Committee – Public Hearing

RE: To review proposed legislation by the U.S. Department of Treasury regarding the regulation of over-the-counter derivatives markets, part one.

Panel I

  • Mr. Jon Hixson, Director, Federal Government Relations, Cargill, Inc., Washington, D.C.
  • Mr. Glenn English, President, National Rural Electric Cooperatives Association, Washington, D.C.
  • Mr. Dave Schryver, Executive Vice President, American Public Gas Association, Washington, D.C.
  • Mr. Richard B. Hirst, Senior Vice President and General Counsel, Delta Air Lines, Minneapolis, Minnesota

Panel II

"Congress should only require mandatory clearing of standardized interdealer over-the-counter derivatives transactions in which at least one of the dealers is systemically significant, the chief executive officer of the International Swaps and Derivatives Association told lawmakers yesterday.

Both the Treasury Department’s proposed legislation and a bill sponsored by the chairmen of the House Financial Services and Agriculture committees would mandate central clearing and exchange trading of standardized derivatives contracts.

But Robert Pickel, the ISDA’s CEO, told members of the House Agriculture Committee yesterday, “Not all standardized contracts can be cleared.”

Pickel said that derivatives contracts that are infrequently traded, even if they have standardized economic terms, “are difficult if not impossible to clear” because a central counterparty clearing facility’s ability to clear a contract depend on such factors as liquidity, trading volume and daily pricing.

This “makes it difficult for a clearinghouse to calculate collateral requirements consistent with prudent risk management,” Pickel said. “End-users are not systemically significant and ­regulations intended to improve stability and decrease systemic risk should not ­apply to them.”

Jonathan Short, senior vice president and general counsel of the ­IntercontinentalExchange Inc., also said Congress should focus regulation on the segments of the market where risk is greatest.

“Mandating that interdealer and major swap participant trades be cleared would eliminate the bilateral counterparty risk that was central to the liquidity crisis that occurred last year,” he said.

Pickel also argued against mandatory exchange trading of OTC derivatives, warning it “would undercut their very purpose: the ability to tailor custom risk-management solutions to meet the needs of end-users.”

Dan Budofsky, a partner at Davis Polk & Wardwell LLP, who testified on behalf of the Securities Industry and Financial Markets Association, agreed that “it may be more appropriate for products that trade less frequently to trade over-the-counter.”

Witnesses also challenged the Treasury’s plan to impose capital requirements on cleared swap transactions. This would require the end-user businesses to post collateral for the swaps, Budofsky said.

Collateral requirements for corporate end-users “would create a significant ­disincentive to use swaps to manage risk,” he said.

Gary Gensler, chairman of the Commodities Futures Trading Commission, has suggested that end-users could other assets as collateral instead of cash.

However, this would expose businesses “to unacceptable levels of risk,” Budofsky argued.

Committee chairman Collin ­Peterson, D-Minn., stressed that he does not want to limit companies’ ability to engage in swaps.

“We’re not really here to put you in a tougher position,” he said. “But in the process I don’t want to leave a loophole that will get us back in this position. We are not going back to the system we had ­before.”</p>

The House Financial Services Committee is expected to mark up derivatives legislation October, said a spokesman for Peterson. Both committees agreed in July to cooperate on derivatives regulation. The spokesman said the derivatives bill, which was already approved by the Agriculture Committee, might have to be “massaged” at some point to mesh with the Financial Services Committee legislation."

Joint hearing Agriculture Financial Services hearing July 10

Joint Committee hearing of the House Agriculture and House Financial Services Committee announced for Friday, July 10th at 10:00am. Treasury Secretary Geithner to testify (testimony link).

"Frank, in an interview with MSNBC (running time 5:35) after the hearing, said he would further limit the ability of businesses to enter into individualized derivative contracts.

"We will specifically be requiring that in almost every case derivatives go on an exchange ... or a clearinghouse, that there not be these individualized deals," he said. "And if people are going to make individualized deals, they're going to have to have a lot more capital behind it. "

Frank also said he would call for a ban on so-called naked credit default swaps, a type of derivative where buyers have no risk of exposure.

Some Democrats have called for fewer customized derivatives contracts and a few have urged that some derivatives, such as credit default swaps, be banned."

"A major battle is brewing, however, over definitions. At root it boils down to how regulators and the market determine the difference between a standardized derivative and a customized derivative.

In his testimony before a joint hearing of the House Financial Services Committee and House Agriculture Committee, Geithner said that the administration would use a “broad definition” of standardized derivatives that would be “difficult to evade.” The administration proposal would raise capital requirements for customized derivatives, “given their higher levels of risk.”

Geithner said that the administration would likely recommend broad principles in statute and then define them further in regulation.

Banks and a range of other non-financial firms are lobbying heavily on derivatives legislation, which is one part of the administration’s plan to revamp regulations for the wider financial system.

Four major Washington lobbying associations -- Business Roundtable, U.S. Chamber of Commerce, National Association of Manufacturers and The Association of Food, Beverage and Consumer Products Companies -- wrote in a letter on Friday that the proposal would increase the cost of business. “We urge you to prevent an anti-derivatives sentiment from translating into anti-business legislation,” the associations wrote.

A separate letter from 15 associations representing the electric power and natural gas industries raised concern with the mandatory clearing provision and the effort to move OTC derivatives onto public exchanges. The proposals, the associations said, would “significantly increase costs,” and “greatly reduce the ability of companies to find the customized derivative products they need to manage their risks.”

Both House committees will have a hand in shaping legislation to regulate the derivatives market. Rep. Collin Peterson (D-Minn.), chairman of the Ag committee, said on Friday that lawmakers would likely not take up legislation until September. House Financial Services Committee Chairman Barney Frank (D-Mass.) said that the Friday hearing was “well in advance” of when lawmakers would draft and debate legislation.

Still, some lawmakers already are signaling frustration with the administration's proposal.

Rep. Spencer Bachus (R-Ala.) said he is concerned that the proposal shifts the risk in the derivatives market to taxpayers. Bachus said that the five largest companies that deal in derivatives, all major banks, will likely be deemed “systemically significant” by federal regulators. In doing so, taxpayers could be on the hook if those companies fail because of poor trades in derivatives.

Rep. Maxine Waters (D-Calif.) introduced legislation on Thursday that would go further than the administration proposal by banning all credit default swaps, one form of derivatives.

“Unless credit default swaps are banned entirely, I am concerned that the industry will find a way to loosen standards and widen exemptions for customized contracts and then we will be right back to where we are today, with capital markets hobbled and the financial system in need of additional government intervention,” said Waters.

Credit defaults swaps were a major factor in the meltdown at insurer AIG, which has since received $182.5 billion in bailout funds from the government."

HR 977 --Agriculture Committee

The House Agriculture Committee approved H.R. 977 - which has been deferred indefinitely

  • -- Require most non-exchange (OTC) derivatives to be settled through a registered CCP
  • -- Gives the CFTC some authority to suspend trading in CDS

HR 2454 Energy Committee

The House Energy Committee approved H.R. 2454 (deferred to other Committees)

-- Includes prohibition of "naked" CDS sales

References

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