The Obama administration Tuesday sent to Congress legislative language that calls for comprehensive regulation of over-the-counter (OTC) derivatives markets and dealers for the first time.

The regulatory reforms — which were outlined in May — call for all standardized OTC derivatives, including energy transactions, to be centrally cleared; require higher capital and margin requirements for non-standardized derivatives; extend the scope of regulation to include OTC derivative dealers and major market participants; and give the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) stricter enforcement authority, and the power to set position limits and large trader reporting requirements for OTC derivatives (see Daily GPI, May 14).

CFTC Chairman Gary Gensler called the administration’s proposal “a very important step toward much-needed reform,” saying he believes that “all over-the-counter derivatives and dealers should be brought under comprehensive regulation.”

The legislative language will require standardized OTC derivatives to be centrally cleared by a derivatives clearing organization regulated by the CFTC or a securities clearing agency regulated by the SEC, according to the Treasury Department’s proposed legislative reforms. Standardized OTC derivatives further would be required to be traded on a CFTC- or SEC-regulated exchange or a CFTC- or SEC-regulated alternative swap execution facilities, it said.

By imposing higher capital requirements and higher margin requirements for non-standardized derivatives, the Obama administration seeks to encourage substantially greater use of standardized derivatives and move more of the transactions onto central clearinghouses and exchanges. An OTC derivative that is accepted for clearing by any regulated central clearinghouse would be presumed to be standardized, the administration said.

According to the legislative language, the CFTC and the SEC would be given clear authority to prevent attempts by market participants to use “spurious customization” to avoid central clearing and exchange trading.

The legislative proposal would require, for the first time, federal supervision and regulation of any firm that deals in OTC derivatives and any firm that takes large positions in OTC derivatives. OTC derivative dealers and major participants that are banks would be regulated by the federal banking agencies. OTC dealers and major participants that are not banks would be regulated by the CFTC and SEC.

The CFTC and the SEC would be required to issue and enforce strong business conduct, reporting and record-keeping (including audit trail) rules for all OTC derivative dealers and market participants.

The administration’s proposal would give the CFTC and the SEC “clear, unimpeded authority” to deter market manipulation, fraud, insider trading and other abuses in the OTC derivative markets (see Daily GPI, June 18). To achieve this, the two agencies would have the authority to set position limits and large trader reporting requirements for OTC derivatives that perform or affect a significant price discovery function in regulated markets (see Daily GPI, Aug. 6; July 29).

And to protect unsophisticated investors, the legislative language would tighten the definition of eligible investors that are able to engage in OTC derivative transactions.

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