Regulators seek tighter oversight of derivatives

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Associated Press

Posted on October 8, 2009 at 6:06 AM

Updated Thursday, Oct 8 at 6:22 AM

WASHINGTON (AP) — Federal regulators on Wednesday asked a House panel to strengthen proposed legislation that would impose new oversight on derivatives, complex financial instruments blamed by regulators for hastening the financial crisis. Republican lawmakers contend the measure already could eliminate jobs and stifle companies' ability to manage risks.

A potent new coalition of about 170 companies that use derivatives — including Boeing Co., Caterpillar Inc., Ford Motor Co., General Electric Co. and Shell Oil Co. — is lobbying Congress to make the case that legislative proposals to regulate derivatives could severely increase costs for corporate America.

Companies of all kinds use derivatives to hedge against risks — airlines ensuring against spikes in fuel prices, for example. At the same time, the complex products have become a growing vehicle for financial speculation and ballooned into a $600 trillion global market. Regulators say they pose a threat to the stability of the financial system.

A splintered committee, with Democrats themselves split, and vigorous lobbying make it likely the work on the legislation will be lengthy and intense. The panel has scheduled a drafting session and vote for next week. Rep. Barney Frank, D-Mass., the committee's chairman, stressed that the proposal he put forward is "a work in progress." He acknowledged that there may be "gaps" in some areas in the draft as written.

The Obama administration is pressing lawmakers to pass the bill quickly, along with other broader reforms of the financial regulatory system.

In a private meeting on Capitol Hill on Wednesday, Treasury Secretary Timothy Geithner told House Democrats, including Majority Leader Steny Hoyer, D-Md., that regulating derivatives would reduce risk and help companies that rely on the financial instruments save money. The meeting was one of several in recent weeks between senior administration officials and lawmakers.

A final bill isn't likely to clear Congress and land on President Barack Obama's desk until December at the earliest, Frank said. It is considered to be less stringent than the administration's proposal for new oversight on derivatives, which are traded in an unregulated global market.

Frank's proposal is an improvement over the administration plan but still includes "potentially troublesome" requirements, said Rep. Spencer Bachus of Alabama, the committee's senior Republican. By creating a new category called "major swap participants," subject to rules for holding capital against risk, the proposal could force thousands of companies to draw capital away from new investment to use as the required collateral, Bachus said.

"It seems counterintuitive during a recession, with unemployment approaching 10 percent, to leave companies exposed to greater risk, raise their cost of capital, and make economic recovery more difficult to achieve," he said.

But Frank's fellow Democrat Mel Watt of North Carolina said the proposal may not be strict enough, by creating loopholes that could allow some big financial firms that deal in credit swaps to skirt regulations.

The proposals are designed to bring transparency to, and prevent manipulation in the sprawling derivatives market. Credit default swaps, a form of insurance against loan defaults, account for an estimated $60 trillion of that market. The collapse of the swaps brought the downfall of Wall Street banking house Lehman Brothers Holdings Inc. and nearly toppled American International Group Inc. last fall, prompting the government to support the insurance conglomerate with about $180 billion in aid.

The value of derivatives hinges on an underlying investment or commodity — such as currency rates, oil futures or interest rates. The derivative is designed to reduce the risk of loss from the underlying asset.

Gary Gensler, the chairman of the Commodity Futures Trading Commission, called Frank's proposal "an important contribution" toward achieving comprehensive oversight of derivatives but urged changes "to ensure that we cover the entire marketplace without exception."

"The American public needs to benefit from the full transparency" that would come from mandating most derivatives go through a new network of clearinghouses and be traded on regulated exchanges, he said.

Henry Hu, director of the Securities and Exchange Commission's new division of risk, strategy and financial innovation, said "relatively simple changes to the discussion draft would ensure that the legislation results in the improved supervision" of the derivatives market.

Unlike Gensler, Hu didn't advocate mandatory exchange trading of derivatives, saying the needed transparency would be provided by the system of clearinghouses.

The big banks that dominate the over-the-counter derivatives market have committed to targets in expanded central clearing systems in a voluntary program.

While more than 1,000 U.S. banks trade derivatives, five big institutions — JPMorgan Chase & Co., Goldman Sachs Group Inc., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. — account for 97 percent of the total reported to be held by U.S. banks.

The torrent of lobbying over derivatives legislation also has included the big Wall Street banks, commodities traders and hedge funds.

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Associated Press Writer Anne Flaherty contributed to this report.

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