U.S. banks prepare to battle over OTC derivatives

By Steve Eder and Rachelle Younglai - Analysis

NEW YORK/WASHINGTON (Reuters) - The banking industry is gearing up for a battle over the lucrative derivatives market, but will have to fight hard to head off a crackdown by regulators.

Calls to regulate the $450 trillion (276 trillion pounds) private market -- long seen as the Wild West of the financial services sector -- have been building for months. Policymakers were caught off guard when a type of derivative -- credit default swaps -- nearly toppled insurer American International Group and global financial markets.

Upping the ante, the Obama administration provided further details on Friday on plans to clamp down on dealers such as JPMorgan Chase and Goldman Sachs Group, subjecting them to much stronger supervision, conservative capital requirements and business conduct rules.

The administration is also pushing for "substantially" greater use of standardized derivatives, clearinghouses, exchanges and regulated electronic trading venues.

That has frightened over-the-counter dealers who have long dominated the market and are concerned an influx of standardized contracts could eat away at their profits. Many other companies, including financial firms, that use derivatives to hedge against price fluctuations are also nervous about the proposals.

Heading off or at least softening the proposals have emerged as a key priority for the powerful business lobby, which is quietly getting ready to make its case to lawmakers.

Banking lobbyists beat back derivatives regulation efforts in the late 1990s, but their success is far from certain this time.

"There is a difference now because you've had the meltdown and swaps have been identified as a problem area," said Michael Greenberg, a law professor at the University of Maryland, who was director of the division of trading and markets at the Commodity Futures Trading Commission in the late 1990s. "The telling thing that will make this battle closely fought, as opposed to other times, is that there's another side."

This time, banks will contend with opposition from consumer, union and industrial groups, as well as trading exchanges.

The exchanges industry, for example, has quietly applauded the administration's push for more exchange trading, which could significantly boost their volumes, while pointing out they have suffered no major breakdowns during the crisis.

Lobbyists for all sides will need to make their cases to lawmakers such as influential Representative Barney Frank, whose House Financial Services Committee is working on a broader financial regulation package. Frank has already introduced legislation to create a new agency to supervise financial products provided by banks -- much to the industry's dismay.

"We are worried that over-regulation could stifle the market," said Scott Talbott, senior vice president with the Financial Services Roundtable, which represents the largest financial services firms.

"We are for disclosures, but have concerns that efforts to create one-size-fits all will harm the markets."

A DIFFERENT KIND OF CAPITAL

The banking and business industry have an interest in protecting derivatives -- and considerable capital to spend in Washington.