Senate Agriculture Committee Chair Blanche Lincoln (D-AR) Friday came out with a much-anticipated bill aimed at reining in commodities market speculation by forcing over-the-counter (OTC) derivative trades onto regulated exchanges and clearinghouses. As expected, it would include an exemption for large commercial traders who use derivatives to hedge the risk associated with trading of physical products.
The bill could significantly restrict trading by large Wall Street banks, such as JPMorgan Chase & Co. and Goldman Sachs Group, by barring swaps dealers from receiving any type of federal assistance (including federal deposit insurance, and access to the Federal Reserve discount window) in connection with their trading of derivatives. As a result the measure could force the banks to spin off their lucrative derivatives operations.
The agriculture committee's bill was considerably stronger than was originally proposed by the Obama administration. In a letter to Lincoln last Thursday, Treasury Secretary Timothy Geithner backed reform of the derivatives market.
"I know there is substantial resistance from lobbyists for the financial industry. But with $600 trillion in notional [derivatives] contracts outstanding, getting this [bill] right is at the core of any effective and meaningful Wall Street reform," Geithner wrote to Lincoln. "Even as we protect the ability of American commercial enterprises to effectively manage their risks, we cannot allow loopholes that would permit dealers and other major participants in these markets to escape meaningful oversight. Our reforms must be strong enough to prevent the next AIG."
Under the legislation swap dealers would be subject to a number of requirements -- reporting, record-keeping, business conduct standards, documentation and back office standards, as well as capital and margin requirements. The bill would require swap dealers to register with the Commodity Futures Trading Commission (CFTC) within one year of enactment of the date of the bill.
"The days of backroom Wall Street deals are over. This is the strongest Wall Street reform bill to date," Lincoln said. "Financial institutions will have to decide if they want to be banks or if they want to engage in the risky financial trading that caused the collapse of firms such as AIG."
The bill calls for mandatory exchange trading and clearing of standardized derivative contracts. However, commercial end-users would be exempted from mandatory clearing of derivative swaps. "These end-users can opt out of the clearing requirement for the swaps only if they are hedging commercial risk," it said. "Financial entities may not claim this exemption."
A swap that is subject to mandatory clearing must be traded through a designated contract market or swap execution facility that makes the swap available for trading, according to Lincoln's bill.
Derivatives transactions would be exempt from "initial and variation" margin requirements if one of the counterparties is not a swap dealer or major swap participant, who holds a substantial position in swaps but is not a swap dealer.
Under the measure, the CFTC would be awarded authority to impose position limits on swaps that perform or affect a significant price-discovery function with respect to registered entities and require aggregate limits across markets. The bill directs the agency to institute expedited rulemakings to implement its provisions.
And the CFTC would have exclusive enforcement authority over swaps except for certain prudential provisions (Federal Reserve) relevant to swaps entered into by banks or branches or agencies of foreign banks that are swap dealers or major swap participants.
The Natural Gas Supply Association (NGSA), which represents major natural gas producers, was one of several groups awaiting the release of the bill, especially the language on the exemption. "The devil's in the details. It depends on how the exemption [provision] is written, how narrow it is. If it's [too] narrow, who are you going to be doing business with," said Jenny Fordham, NGSA director of energy markets and government affairs. "That's kind of the $900 billion question."
Looking to the entire derivatives market, mandated exchange trading or centralized clearing and margining could drain the U.S. economy of approximately $900 billion in productive capital that companies would simply have to post or set aside to insure their risk-management transactions, the NGSA and National Corn Growers Association wrote in a joint letter Thursday to Lincoln; Sen.Saxby Chambliss of Georgia, the ranking Republican of the Senate agriculture panel; and Senate Majority Leader Harry Reid (D-NV).
In a joint letter to Congress in December, the NGSA and the American Exploration and Production Council estimated that mandatory clearing of OTC derivatives would cost the oil and natural gas industry $100 billion.
Lincoln will probably begin marking up her legislation this week, a committee staffer told NGI. If it clears the Senate agriculture panel, the bill would then be sent to the Senate floor where it would be folded into the broader legislation overhauling the financial regulatory system that was passed out of the Senate Banking Committee last month (see NGI, March 29).
As to its chances of passage, Lincoln has the votes in committee, an industry lobbyist said. He pointed out that when it goes to the floor, "it's not health care; if the Democrats can keep their caucus together, they shouldn't have too much trouble getting a couple [of] Republicans to go with them...maybe the two Maine senators, maybe [Chuck] Grassley, [R-IA]. It looks like the agricultural industry will back the bill and they can put pressure on some Republican lawmakers. The new wild card is the Tea Party. We don't know how they will react. They don't have a platform. If the Republicans want to kill this, they'll have to get the Tea Party on board, and that brings a lot of unknowns."
The derivatives part of the sweeping financial regulatory reform measure was at one time considered the least controversial section of the legislation, but that's no longer the case. It has become highly partisan on Capitol Hill, with Republicans vowing to oppose it on the Senate floor, as well as off Capitol Hill.
In meeting with Senate and House leaders last Wednesday, President Obama expressed confidence that lawmakers could work out an effective, bipartisan package. But he "made clear that bipartisanship should not be equated with an openness to lobbyists' loopholes and special interest carve-outs and that he would be unwilling to negotiate on some key issues. And that he could not accept bad policy in pursuit of bipartisanship," according to White House spokesman Robert Gibbs.
Obama called the OTC derivatives market a "shadow economy that is enormously powerful...We want to get that into daylight so that regulators and ordinary Americans know what's going on."
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