Lawmakers to consider derivatives bill this fall

House lawmakers will begin considering legislation in September that would restrict the largely unregulated market for derivatives by increasing capital requirements and possibly banning a controversial part of the market.

Lawmakers and critics blame the multitrillion-dollar market for exacerbating the financial crisis and bringing insurance giant AIG to its knees. Traders and users of derivatives say the complicated financial instruments are an essential way to hedge risk.

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House Financial Services Committee Chairman Barney Frank (D-Mass.) and House Agriculture Committee Chairman Collin Peterson (D-Minn.) said on Thursday they intend to shed light on what is essentially a dark market by bringing most derivatives onto public exchanges and having them settled by central clearinghouses.

The two committees, which oversee the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), aim to overcome jurisdictional and turf questions in what is one of the most complicated areas of the financial system.

The legislation, Frank said, will be wrapped into the broader effort by the Obama administration and Congress to revamp the financial regulatory system. The outline announced on Tuesday largely tracks the Obama administration’s views on derivatives.

The two House committees will be negotiating tough questions over which products fall under SEC or CFTC regulation.

Peterson, whose committee oversees CFTC, leans in favor of granting that agency power because it is more “nimble.” Lawmakers also envision a financial oversight council that would resolve disputes between the two regulatory agencies, particularly as new products are developed.

Frank said the two committees are “not in entire agreement,” but that “none of the remaining areas are deal-breakers.”

The highly nuanced derivatives market is one of the most heavily lobbied areas of the financial overhaul and has been a major source of financial innovation and profit in recent years.

U.S. commercial banks recorded record revenues of $9.8 billion in the first three months of this year on trades in cash and other derivative instruments, according to the Office of the Comptroller of the Currency.

Industry groups and lawmakers have wrestled over the question of which derivatives are sufficiently standardized that they can be traded easily on public exchanges. Business groups have pushed back hard on suggestions that all derivatives — including those to hedge against currency, interest rate or credit problems — should be placed on exchanges, arguing that such a move would hamper the benefits of the market.

Frank and others said they were looking at ways to provide strong incentives, including capital and margin requirements, for companies to trade in standardized derivatives.

A lingering unresolved question is whether lawmakers should move to prohibit “naked” credit default swaps (CDS), a type of derivative transaction where traders do not own the underlying asset or security. Lawmakers said they were considering such a ban but may instead move in favor of enhanced oversight of speculative positions.

Such a move would grant regulators the ability to impose position limits and timeouts in the market, Frank said.

The legislation envisions stripping the Federal Reserve of oversight of the clearing of the CDS market.

“Barney and I want to err on the side of too much regulation,” Peterson said.

Frank also said that his committee would work on separate legislation on municipalities and other users of derivatives.