Derivatives bill to clamp down on speculation

WASHINGTON Mon Jul 27, 2009 4:32pm EDT

A trader in a file photo. REUTERS/File

A trader in a file photo.

Credit: Reuters/File

WASHINGTON (Reuters) - Congress will consider steps to curb speculation in the $39 trillion credit default swaps market and could prohibit investors from speculating on a borrower's credit quality, according to a U.S. House of Representatives Committee document obtained by Reuters.

Congress and the Obama administration have been pushing for oversight of the market since insurer American International Group Inc's near-collapse because of its exposure to credit default swaps. The swaps are used to insure against debt defaults and speculate on a borrower's credit quality.

The House Agriculture and Financial Services committees will consider two options to curb speculation including a ban on so-called naked credit default swaps -- swaps for which a trader or investor does not hold the underlying asset being insured, such as a bond.

The other option would require derivative dealers and investment advisers that manage in excess of $100 million to report their short interests in credit default swap contracts to the appropriate regulator, according to the document.

The derivatives bill is part of a broad overhaul of U.S. financial regulation sought by the White House and Democratic lawmakers in the House and Senate.

The House is expected to begin debating this week a separate measure that would give shareholders the right to cast nonbinding votes on executive compensation at publicly traded companies.

Policymakers have been broadly pushing for oversight of the $450 trillion over-the-counter derivatives market, which includes the credit swaps.

The bill would give regulators authority to set position limits on dealers in credit default swaps, or CDS. It would also shift oversight of ICE Trust Clearinghouse from the Federal Reserve to the Securities and Exchange Commission, the document said.

The bill also addresses the role of clearinghouses, which act as intermediaries that assess risk from transactions, assign capital or margin requirements, and assure payment if one party defaults.

The Obama administration wants more over-the-counter derivatives -- which are not traded on exchanges -- to be cleared by clearinghouses. The draft bill takes a stronger line, saying derivatives must be traded on an exchange and cleared by approved clearinghouses unless regulators decide to exempt them.

Waivers could include illiquid derivatives, those that are customized, and those in which a so-called end user of derivatives does not qualify as a "major market participant," the document said.

The draft bill from Barney Frank's House Financial Services Committee is similar to a description by Agriculture Committee chairman Collin Peterson of an upcoming omnibus reform bill.

"They had come to agreement on the bulk of what Frank would propose," a House Agriculture Committee spokesman said about the discussions between Peterson and Frank.

The Agriculture Committee passed a bill last winter that would, if enacted into law, require clearing of OTC derivatives in most cases and would allow regulators to temporarily suspend trading in naked CDS.

The bill also would require futures regulators to set position limits on agricultural and energy contracts and require foreign exchanges to adopt reporting and disclosure rules that mirror U.S. standards.

Under the draft bill, a new federal council would help resolve long-standing differences between futures and securities regulators, the Commodity Futures Trading Commission and the SEC.

The CFTC polices futures markets and the SEC oversees stock markets. The two bodies have long clashed over which has the right to approve new financial products, delaying approvals.

The new council would determine which agency had authority over the new products within 180 days and resolve jurisdictional disputes between the SEC and the CFTC within the same time frame.

The White House is expected to release its proposed legislative language for derivatives as early as Thursday, according to a source familiar with the administration's planning.

A spokeswoman for ICE had no comment on the draft proposal.

(Reporting by Rachelle Younglai and Chuck Abbott; Additional reporting by Jonathan Spicer in New York; Editing by Gerald E. McCormick, Gary Hill)

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