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Senate Draft Offers Exemptions for Clearing, Trading of Derivatives

Senate Banking Committee Chairman Christopher Dodd (D-CT) circulated a discussion draft last Tuesday that would require over-the-counter (OTC) derivative products to be centrally cleared and traded on regulated exchanges if they do not receive an exemption from federal regulators overseeing the futures and securities markets.

The 1,100-plus page draft would allow the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) to exempt a derivative swap from the clearing-trading requirements if one of the parties to the swap is not a swap dealer or a major swap participant, or no derivative clearing organization will accept the swap for clearing.

The draft contains similar exemption language that was included in legislation that was voted out by the House Financial Services Committee (HR 3795) and House Agriculture Committee last month (see NGI, Oct. 26; Oct. 19). The House legislation proposes to exempt end-users, such as energy producers and consumers, from the clearing/trading requirement if they use derivative products to hedge commercial risk. An exemption would not extend to a swap dealer or major swap participant, such as a financial institution.

"I am pleased at the progress Sen. Dodd and other members of the Senate have made. Obviously the bills aren't going to be identical, but it confirms that we are moving in the same direction and reaffirms my confidence that we are going to be able to get an appropriate, effective reform package passed very soon," said House Financial Services Chairman Barney Frank (D-MA). He said the House may debate the bill next month.

Dodd indicated the banking panel may begin marking up his measure in early December. The bill is expected to run into serious problems in the banking committee, as Sen. Richard Shelby of Alabama, the ranking Republican on the panel, and other Republican committee members do not support Dodd's reform proposals.

Under the Dodd draft, counterparties to swap transactions that are not accepted for clearing will be required to report the swap to a registered swap repository to improve market transparency.

Traders also will be required to post margin and capital on trades that are not cleared in order to offset the greater risk that they pose to the financial system and to encourage more trading in regulated markets.

Derivatives, which were blamed in part for the financial meltdown last fall, are used by energy producers and large consumers to hedge against price fluctuations and other business risks. The draft, as well as the House legislation, would enhance the CFTC's and the SEC's authority over the heretofore unregulated $500 trillion OTC derivatives market.

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