Frank works to tighten oversight of derivatives in financial legislation

The House Democrat spearheading financial overhaul legislation said on Wednesday that lawmakers are still closing loopholes and altering a major bill that regulates the multitrillion-dollar market for financial derivatives.

House Financial Services Committee Chairman Barney Frank (D-Mass.) scheduled a meeting next week to mark up legislation intended to bring transparency to the market by imposing new curbs on dealers and users of derivatives.

“I think there is some room now to tighten up some of what we are doing,” Frank said.
Frank’s legislation represents an effort to narrow the Obama administration’s original proposal to win support in response to lobbying opposition from a broad range of industries and concerns voiced by centrist Democrats.

The changes have garnered praise from parts of the financial industry, but they have also raised worries among federal regulators that gaps in the system might persist.

Officials at the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) testified that the bill could leave holes in the regulatory system and possibly permit different rules from each of the two regulators.

The Frank bill is likely to gain steam with the initial praise from financial firms and centrist New Democrats on the committee. The bill represents a key part of a broader financial overhaul the Obama administration aims to enact this year or early in 2010.

The House Agriculture Committee, which has jurisdiction over the CFTC, is also working on derivatives legislation, but the committee has yet to announce a timeline for votes. House Democrats said they would schedule votes in November, while action in the Senate may take longer.

Lawmakers have criticized derivatives, which are tools to hedge risk in a variety of transactions, for exacerbating the financial crisis and crippling firms, such as Lehman Brothers and American International Group (AIG). The market for financial derivatives is made up of trades between two parties without any central or third-party oversight.

The dealer market for financial derivatives is highly concentrated among five Wall Street banks that have recorded billions of dollars in profit on cash and derivatives trades in 2009, despite the crisis. The banks have waged a major lobbying campaign on Capitol Hill to weaken the proposed derivatives regulations.

Financial lobbyists have teamed up with representatives of big business — largely the banks’ clients — to make their case before wary lawmakers.
Lobbyists, lawmakers and federal regulators are looking to alter a range of provisions in the bill:

• Henry Hu, an SEC official, and Rep. Mel Watt (D-N.C.) raised concerns about a provision in the bill related to major dealers and participants in swaps, one type of derivative. Hu said the proposed measure exempting transactions for “risk management” needs is overly broad and ill-defined.

The issue was highlighted when CFTC Chairman Gary Gensler said Fannie Mae and Freddie Mac, the beleaguered government-sponsored enterprises, would likely receive an exemption from submitting standardized contracts to a central clearinghouse.

• Business lobbyists have formed the Coalition for Derivatives End-Users to sway lawmakers to preserve the market for bilateral trades in customized and tailored derivative products. Gensler pushed for customized derivatives to be cleared in central clearinghouses, but Frank appears to have ruled out that notion. “I don’t think you’re going to see that happen because of the response that many will have to the end-users,” Frank said.

• Frank said there is an open question about whether insurance firms that sell life or automobile insurance should be exempted under the new law. A company such as AIG, an insurance firm that was a major participant in the derivatives market, would be regulated under the bill, Frank said.

• Lobbyists continue to push for better definitions surrounding margin requirements for end-users. Frank included a provision that firms could post other non-cash forms of collateral.

• Lawmakers and regulatory officials continue to look for ways to beef up penalties for the violation of anti-fraud and investor-protection statutes.

---