Top Senate Democrats near derivatives deal: sources

WASHINGTON (Reuters) - The two Democratic Senators charged with writing rules for the $450 trillion private swaps market are near a deal, and will include a provision to require banks to spin off swaps desks, people familiar with the talks said on Sunday.

One source said the U.S. Treasury Department is raising concerns over the restrictions as Senate Banking Chairman Christopher Dodd and Senate Agriculture Chairman Blanche Lincoln try to hash out how best to clamp down on derivatives, blamed in part for accelerating the recent financial crisis.

The Senate votes on Monday on whether to start debating Democrats' bill to impose strict rules for banks, capital markets and derivatives -- one of the most contentious parts of the proposed legislation.

Sources said Senate Democrats' bill will incorporate the major features of what was proposed by Lincoln, whose reforms went further than plans from the Senate Banking Committee, the Obama Administration, and the House of Representatives, which passed its reform bill in December.

But although Democrats have reached an agreement, Lincoln's rules will face an uphill battle in the full Senate given that the Obama administration has raised concerns.

One source said that Lincoln was pressuring Dodd and the White House to accept her provision to restrict banks such as Goldman Sachs and JPMorgan Chase from the lucrative over-the-counter derivatives market.

Lincoln is fighting for her political survival, facing challenges from a Democratic contender in Arkansas and a tough reelection battle in November.

But other sources said that Dodd may have felt it was necessary to include the ban in order to woo support from Republicans Charles Grassley and Olympia Snowe -- two Senators who have said strong derivatives rules are needed.

At least one of the 41 Republican senators must vote with Democrats on Monday in order to start debate on the financial reform legislation.

Democrats' bill will require most swaps be cleared by clearinghouses to limit the domino effect large, risky trades can have on the economy, sources said. It will require mandatory clearing as well as trading of most swaps on exchanges or other electronic platforms, sources said.

There will be a narrow exception for "end users" -- producers, manufacturers, and other companies that are not financial players who used derivatives to hedge against risk sources said.

The rules will apply to foreign exchange swaps and forwards, unless the Treasury Secretary recommends otherwise.

Many derivatives experts argue taking banks out of the market would mean smaller, less capitalized players in the swaps business, increasing costs for those that use derivatives for hedging.

"If you believe you've put in place an apparatus with the exchange trading, with margining, with clearing, that provides reasonable safeguards, it's not exactly clear why you'd then say, "But we're not going to allow this major source of capital liquidity to participate in those markets,'" said Geoffrey Aronow, partner with Bingham McCutchen in Washington.

"You either believe you've fixed things, or you don't," said Aronow, a former director of enforcement at the Commodity Futures Trading Commission, in an interview last week.

(Reporting by Roberta Rampton, Rachelle Younglai, Charles Abbott and Kevin Drawbaugh; Editing by Bernard Orr)