House and Senate conferees have been called on to clarify in the financial regulatory reform bill that commercial end-users are not to be treated as "swap dealers" and thus are exempt from the requirement to clear over-the-counter (OTC) derivative transactions.

"Although the end-user clearing exemption provided in Title VII of [the legislation] is certainly a step in the right direction, the practical effect of the legislation, without a relatively minor modification to the definition of 'swap dealer,' will be mandatory clearing for many commercial end-users," wrote the Natural Gas Supply Association (NGSA) and National Corn Growers Association (NCGA) to Senate Majority Leader Harry Reid (D-NV) and House Speaker Nancy Pelosi (D-CA) last Monday.

If the language is not clarified in the Senate bill (S. 3217), it could drain hundreds of millions from the energy industry -- and approximately $700 billion economy-wide -- that would otherwise be productive capital and invested in infrastructure and job-generating facilities, said Jenny Fordham, director of government affairs and energy markets for NGSA.

"We believe [our] concern can be addressed by simply clarifying that a swap dealer, by definition, excludes commercial end-users or that the legislation define 'swap dealer' as any person who: 1) holds itself out as a dealer in swaps; 2) makes a market in swaps; 3) regularly engages in the purchases and sale of swaps in the ordinary course of business; and 4) engages in any activity causing the person to be commonly known in the trade as a dealer or market maker in swaps" instead of any any person meeting one of those criteria, NGSA and NCGA said.

"The important thing to bear in mind as the conference begins is that a means of preventing the unintended consequences to the economy and commercial end-users exists and is achievable. Broadening the clearing exclusion to exempt commercial end-users is absolutely essential to avoiding harm to the economy and allowing capital to stay at work in U.S. industry," the groups noted.

The conference committee is expected to start working in June to reconcile the Senate and House bills, possibly hold the first public meeting on June 9, CQ Today reported. House Financial Services Chairman Barney Frank (D-MA) and Senate Banking Committee Chairman Christopher Dodd (D-CT) hope to send a bill to President Obama for his signature by the July Fourth holiday.

"Natural gas companies use the OTC derivatives market as a tool to provide greater price predictability and security to benefit customers. Our companies should not be regulated like swap dealers," Fordham said.

"Natural gas companies have significant physical assets and do not pose the 'systemic risk' that financial reform measures are aimed at preventing. In fact forcing natural gas companies to clear derivatives transactions only serves to centralize risk that would otherwise be diversified among numerous counterparties," she said.

The Senate last month passed the broad-based legislation that calls for a sweeping overhaul of the nation's financial regulatory system, including regulation of the OTC derivatives market for the first time (see NGI, May 24). The Senate and House will now move to reconcile their respective bills in conference (S. 3217, HR 4173). The House passed its financial regulatory reform bill in December (see NGI, Dec. 14, 2009).

Of key interest to the energy industry, the 1,400-page bill seeks to curb commodities market speculation by forcing OTC derivatives trades onto regulated exchanges and clearinghouses. It provides an exemption to the trading/clearing requirement for large commercial traders who use derivatives to hedge the risk associated with trading of physical products. But some, such as the NGSA, don't believe that the exemption is spelled out clear enough.

Derivatives are financial instruments whose price depends upon or is derived from one or more assets, such as energy. Their value is determined by fluctuations in the underlying value. They are mostly used to hedge commercial risk but also can be used for speculative purposes. Some derivatives, such as agricultural commodities, are already traded on regulated exchanges. But OTC derivatives are traded off-exchange and out of the purview of the Commodity Futures Trading Commission. Misuse of derivatives was blamed in part for the financial crisis of 2008.

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