For producers last week, the jury was still out on how the Obama administration’s legislative package to tightly regulate the $500 trillion over-the-counter (OTC) derivatives market would impact them, but there was some cautious relief.

The 115-page legislative proposal, which the Treasury Department sent to Capitol Hill last Tuesday, “seems to be targeting…dealers rather than end-users,” such as oil and gas producers, in the OTC derivatives market, said Lee Fuller, vice president of government relations for the Independent Petroleum Association of America, which represents independent producers.

“At this point we think that the administration is hearing the message of producers [about] the importance of commodity market hedging to managing capital,” he said.

The Obama legislative language “appears to be maintaining a lot of [the] flexibility” to give producers a “stable market to operate [in when] planning capital,” Fuller noted. With hedging, producers “create financial certainty for their production over multi-year time.”

But Fuller wasn’t ready to endorse the entire legislative package. “This is a complicated structure…A lot of it hinges on the details. Some of it hinges on what constitutes standardized [derivatives] contracts and what constitutes customized contracts.”

The American Petroleum Institute (API), which represents major oil and gas producers, was still combing through the Obama legislative proposal and was equally as cautious in its comments. “We certainly do not oppose additional transparency in the marketplace,” as is proposed by the Obama administration, said API spokeswoman Cathy Landry.

But “we believe that OTC derivatives regulatory reform should not jeopardize business efforts to manage risks, and businesses must be able to participate in bilateral transactions as a hedging tool,” she said.

On the plus side, it appears that producers “wouldn’t have to post cash collateral” for their hedges in the OTC derivatives markets under the legislative language, but Landry fears there may be other things in the package that could affect producers’ ability to hedge or manage their risk.

The administration’s legislative language calls for all standardized OTC derivatives, including energy transactions, to be centrally cleared; requires higher capital and margin requirements for non-standardized derivatives; extends the scope of regulation to include OTC derivative dealers and major market participants; and gives 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. The intent of the combined measures is to curb excessive speculation in OTC derivatives markets.

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, a preview of which was unveiled earlier this summer, 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 NGI, June 22). 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 NGI, Aug. 10, Aug. 3).

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

House and Senate lawmakers will consider incorporating some of the Obama language in their bills. The heads of the two most powerful House committees overseeing derivatives markets came together earlier this month on the framework for legislation that would enhance federal regulatory authority to crack down on excessive speculation in OTC markets (see NGI, Aug. 3).

In many respects the Obama legislative package mirrors the House proposal. The agreement between House Financial Services Committee Chairman Barney Frank (D-MA) and House Agriculture Committee Chairman Collin Peterson (D-MN) calls for “robust oversight” of OTC derivatives dealers, exchanges and clearinghouses by the SEC and the CFTC. It gives the agencies the authority to prohibit or regulate transactions that are not traded on an exchange or cleared; to set “significantly higher capital and margin charges” on transactions that are not traded on exchanges or centrally cleared; and to set position limits to curb excessive speculation.

A similar bill was introduced in the Senate earlier this year by Sen. Tom Harkin (D-IA), chairman of the Senate Agriculture Committee. It seeks to bring all OTC financial transactions, which currently are traded without federal oversight, onto regulated exchanges.

©Copyright 2009Intelligence Press Inc. All rights reserved. The preceding news reportmay not be republished or redistributed, in whole or in part, in anyform, without prior written consent of Intelligence Press, Inc.