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Gensler: No Free Pass for OTC Derivatives End-Users

November 2, 2009
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Unlike legislation passed out of two House committees in October, the head of the Commodity Futures Trading Commission (CFTC) last Tuesday said he does not believe there should be any exception to clearing and trading of standardized over-the-counter (OTC) derivative products.

"Most transactions that you enter into now -- hedging transactions to hedge the price of natural gas -- are entered into with large Wall Street firms...Our concept is that we want to move as much of that over into regulated clearinghouses," CFTC Chairman Gary Gensler said during a Natural Gas Roundtable meeting in Washington, DC.

"Why is that? Well, the large financial firms are so interconnected...We think the system is protected better if those transactions are moved into [a] central clearinghouse and the clearinghouse has to have capital and risk [management benefits].

"I believe that the benefit of centralized clearing to lower risk and [the] benefit of trading platforms to increase risk transparency are significant for the public and that we should work to bring as many [standardized] transactions in as we can," Gensler, the first CFTC chairman to address the roundtable, told reporters.

"Now there are customized and tailored transactions that would not be in there [clearing/trading]" because these products "would, by definition, be something that a clearinghouse felt they couldn't clear and couldn't bring into their central clearinghouse. [However,] it's very important that their risk management be strong and be well regulated.

"If a clearinghouse accepts something for clearing, subject to the [Securities and Exchange Commission's] and CFTC's rule-writing...I think that should be a presumption that it's something that would be cleared. If it's then listed on a trading venue, that should be a presumption that it [would] benefit from the transparency of those trading venues.

"Whether it's a transaction between two swap dealers or a transaction between a swap dealer and a hedge fund or a swap dealer and a public utility, all of those the public would benefit [from] and markets would benefit by bringing those onto these trading platforms."

Legislation approved by the House Agriculture Committee and House Financial Services Committee last month would exempt "end-users," such as natural gas producers and industrial consumers, from having to clear their OTC derivatives transactions and trade them on regulated exchanges if they use derivatives to hedge commercial risk (see NGI, Oct. 26a, Oct. 19).

But Gensler has recommended that "where possible to bring as many of those [derivatives transactions] into clearing," including those involving end-users.

He noted that House Agriculture Committee Chairman Collin Peterson (D-MN) and House Financial Services Committee Chairman Barney Frank (D-MA) currently are working to reconcile their two bills and expect to bring legislation to the House floor this week. The legislation would mark the first time that U.S. derivatives markets, which has a notional value of $250 trillion to $350 trillion, will be regulated.

If Congress, in the end, should decide to exempt derivatives transactions with some end-users from a clearing/trading requirement, Gensler said the exception should be "explicit and narrow." He said it was "most critical" that transactions with financial firms, hedge funds and other investments be cleared.

Gensler dismissed reports that Jon Wellinghoff, chairman of the Federal Energy Regulatory Commission, is concerned the CFTC is stepping on its jurisdiction with its review of certain natural gas and electricity contracts. The CFTC is examining contracts to determine whether they serve a significant price discovery function (SPDF), and should be subject to position limits (see NGI, Oct. 26b, Oct. 12). "I think we have a very good relationship with other regulators -- the FERC, SEC...at a staff level and chairman level," he said, adding that he was not aware of the reports.

Gensler also declined to comment about the push-back that the CFTC was getting from gas associations with respect to the agency's review of contracts to determine they had a SPDF (see related story). "We're in the determination phase." He estimated that the CFTC currently has identified 30-40 contracts for SPDF review. "I don't know where the number will end up."

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