Senators can't agree on OTC derivatives rules

WASHINGTON (Reuters) - U.S. senators charged with crafting rules to regulate the $450 trillion over-the-counter derivatives market have failed to reach an agreement, Democratic Senator Jack Reed said on Friday.

Reed and Republican Senator Judd Gregg had been trying to write rules to shed light on the private swaps market but disagreed on which parties should be allowed exemptions.

"We were not able to reach a comprehensive consensus that would fill dangerous gaps while allowing companies to safely use derivatives to hedge their risks," Reed said in a statement.

Derivatives rules is one of many areas where Republicans and Democrats disagree. On Monday, Senate Banking Committee members will start amending a sweeping financial reform bill crafted by committee chairman Christopher Dodd.

Lawmakers are expected to try to alter much of Dodd's bill, including how banks will be supervised and consumer financial products regulated.

There is agreement that most derivatives should be regulated after credit default swaps, a type of derivative used to bet on whether a company will default on its bonds, contributed to the financial crisis.

Although lawmakers and the White House want to make the derivatives market more transparent, there is disagreement over who should be exempt from new rules. Manufacturers and other nonfinancial firms have argued they need to customize their derivatives to hedge against risks such as fluctuations in commodity prices and inflation.

Sources with knowledge of the issue said Reed had favored a narrow exemption for companies and Gregg had been pushing for more leeway.

Gregg said he was hopeful that lawmakers could continue to work on a bipartisan derivatives deal before the full Senate votes on the financial reform bill. Reed said he was hopeful there will be bipartisan support for bringing derivatives out in the open.

Dodd is under pressure to pass a bill before he leaves the Senate at the end of the year.

One of the Obama administration's key reforms -- an independent watchdog for consumer financial products such as mortgages -- is in danger of being watered down further in the Senate. Dodd has proposed placing the consumer watchdog in the Federal Reserve and giving the watchdog the authority to examine and enforce consumer rules for banks and credit unions with assets above $10 billion.

The consumer regulator would also have authority over mortgage-related businesses and large nonbank financial firms.

Barney Frank, who is in charge of financial regulation in the House of Representatives, said on CNBC TV on Friday that he still favored an independent agency. If the Senate manages to pass a financial reform bill that bill will have to be reconciled with the House version.

Another contentious issue-- the so-called Volcker rule to ban banks from proprietary trading and owning a hedge fund or private equity fund -- will also have to eventually be reconciled with the House.

Dodd has proposed such a ban under his bill, though has said the Volcker rule would wait until after a study by the systemic risk council.

Frank told CNBC that he favored reducing banks' proprietary trading and suggested defining it based on volume.

Frank also said it will be important for financial reform legislation to require lenders who package loans for resale as securities onto the secondary debt market to retain some percentage of the portfolio risk.

(Reporting by Rachelle Younglai and Kevin Drawbaugh; Editing by Andrew Hay and James Dalgleish)