In early round, Congress bends on swaps reform

WASHINGTON (Reuters) - Congress's chief architect on financial regulation said on Wednesday companies that use derivatives to hedge risk would not be forced to comply with all the new rules for the $450 trillion private swaps market.

House Financial Services Committee Chairman Barney Frank said he does not expect Congress to mandate companies to process their swaps through central clearinghouses, which assumes the risk if one party defaults.

"I don't think you're going to see that happen because of the response that many will have," Frank told the U.S. futures market regulator the Commodity Futures Trading Commission.

Frank said there would be a presumption that standardized contracts would go to clearinghouses but it would not be iron-clad. The White House wants clearing to be mandatory.

The committee tentatively plans to write a bill next week, leaving only a few days for some of the world's largest companies that use derivatives and federal market regulators to argue over the scope of reform.

Frank said he was confident the House will pass a reform bill in November. The Senate must agree on legislation before President Barack Obama could sign it into law.

If the derivatives bill becomes law, it may be one of the Obama administration's few successes in Congress this year. The White House's ambitious agenda includes health care and financial regulatory reform and a strong climate change law.

Global policymakers are pushing reforms to remove excessive risks from the derivatives market, after a type of derivative known as credit default swaps nearly toppled insurer AIG Inc and wreaked havoc on the global financial system.

An outline offered by Frank would exempt some derivative swaps from processing by a central clearinghouse, which assumes the risk if one party defaults.

But CFTC Chairman Gary Gensler told Congress that clearing "is essential to lowering risk" and should be the norm.

"The only party that could be opposed is Wall Street, because right now they have all the information," he said, adding that exchange trading helps all market participants by setting prices and terms publicly.

The CFTC and stock market regulator the Securities and Exchange Commission would oversee the swaps market under the House draft bill. Both asked Frank's committee for more robust rules and warned the bill could allow market participants to shop for the weakest rules.

Gensler also took exception with language in the draft that exempts so-called major swap participants who use derivatives to hedge risk. There are hundreds of such participants, which are large companies and hedge funds that not only use derivatives to hedge risk but trade them as well.

"I am concerned that a great number of swaps could be characterized as risk-management, or hedging, swaps," he said.

"This could have the unintended consequence of exempting a broad range of entities ... from regulatory requirements."

Frank stressed that the draft should undergo "significant change" before the committee approves it.

The panel has already moved away from early plans to curb speculation in the $39 trillion credit default swaps market and prohibit investors from speculating on a borrower's credit-worthiness.

The draft bill recognizes that many companies use derivatives for managing risk and does not require the use of only cash as collateral on customized derivatives, an issue for larger companies.

Big bank Morgan Stanley, Deere & Co, the world's largest maker of tractors and harvesters, and mammoth farm exporter Cargill voiced concerns on giving regulators discretion to impose capital and margin requirements on swaps.

That would only apply if one of the counterparties is an end user. "This provision would create an added cost for end users," said James Hill, managing director at Morgan Stanley who was also representing Wall Street lobby the Securities Industry and Financial Markets Association.

(Additional reporting by Kevin Drawbaugh; Editing by James Dalgleish)