The Senate Agriculture Committee Wednesday voted out amended legislation that would bring regulation for the first time to the $600 trillion opaque over-the-counter (OTC) derivatives market (see Daily GPI, April 21).

By a vote of 13-8, the OTC derivatives measure was forwarded to the Senate floor, where it will be folded into broader legislation overhauling the financial regulatory system that the Senate Banking Committee appproved last month (see Daily GPI, March 24). Senate Majority Leader Harry Reid (D-NV) is expected to file a cloture motion on the broader reform bill as early as Thursday, setting the stage for an important test vote first thing next week that could lead to formal consideration of the bill, CQ Today reported.

The manager's amendment, which was offered by committee Chair Blanche Lincoln (D-AR), seeks to curb commodities market speculation by forcing OTC derivatives trades onto regulated exchanges and clearinghouses. It makes an exemption to the trading/clearing requirement 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 (see Daily GPI, April 16).

"This is no time for small fixes" in the OTC market; rather it's time to make "bold changes," Lincoln said. She called the bill, which would bring transparency to a dark market, "historic" in nature. And Lincoln said it was "surgical in its approach." Derivatives are a financial instrument whose value is derived from one or more underlying assets, such as natural gas or electricity. Derivatives, which were partly blamed for the financial meltdown in the fall of 2008, are used by commodity producers and large consumers to hedge against price fluctuations and other business risks.

Although he cited some concerns with the revised bill, Sen. Saxby Chambliss of Georgia, the ranking Republican on the agriculture committee, said "we probably generally agree on 90% of [the] specifics. However, the remaining 10% of the issues involved here, namely the extent of the end-user exemption...are very important because they involve real costs for businesses."

OTC derivatives reform will be a "critical component" and "heart" of the sweeping financial regulatory bill, Lincoln and Chambliss agreed. He noted that reaching agreement between Democrats and Republicans has been a "tough slug fest" because of the complexity of the issues.

Chambliss said the changes in Lincoln's manager amendment, 43 in all, "move us much closer together on some of the fundamental issues."

The revised legislation clarifies that the trading/clearing exemption would apply to end-users (and their affiliates) who use OTC derivatives to hedge the risk associated with all commodities, as well as the manufacturers of goods. "The definition of who is a commercial end-user is not restrictive...There was some concern that our definition did not cover the manufacture of goods, nor did it cover all commodities," a Lincoln staff member said.

In the legislation, "we're trying to indicate that there are a lot of commodities that people use, and it's acceptable for commercial entities to be engaging in [bona fide hedging of] all commodities, not just the listed ones" in the bill, he said.

In addition, "an affiliate of a commercial entity can be actually assisting the parent or another affiliate, which is a commercial entity, in terms of hedging" and qualify for the exemption, the staff member said. The exemption would not apply to financial institutions and other large swap dealers. Under the Lincoln bill, the capital and margin requirements for uncleared transactions would be significantly higher than those for cleared transactions.

The measure also fine-tuned the definition of swap participants to exclude pension funds, and broadened the definition of swap dealer to capture some very large commercial traders that buy swaps all the time, but don't sell them.

Lincoln's revised bill also calls for the permanent establishment of an energy and environmental market advisory committee at the Commodity Futures Trading Commission (CFTC).

Chambliss offered a substitute amendment that was defeated by 9-12. The substitute was based on a bipartisan discussion draft on OTC derivatives reform, which Lincoln, Chambliss and their staffs had worked on for five-six months. A key different between the Republican substitute and the Lincoln bill is that it proposed a broader exemption of the trading/clearing requirement to include businesses (manufacturers, processors or financial institutions), such as a farm credit institution but not a JPMorgan Chase, he said.

He noted that substitute clarified that companies like "Koch Industries [in Georgia] and Goldman Sachs should not be regulated in the same way."

Chambliss said one of the "unintended consequences" of Lincoln's amended legislation would be that small banks, farm credit banks and companies such as Koch would be treated like the Wall Street banks and restricted in their trading of OTC derivatives.

CFTC Chairman Gary Gensler said he was not aware of any farm credit bank that was considered a swap dealer, making it ineligible for the trading-clearing exemption.

Chambliss raised particular concerns about the bill's anti-bailout provision for large swap dealers. "Large banks won't be able to access that [Federal Reserve] discount window if they engage in swap deals. And they account for 99% of the U.S. swap market. So if we cut them out of the swap market, the end-users are not going to have another party that they can engage in swap transactions with."

If the legislation clears Congress, Gensler estimated that the CFTC would need 250 more staff members to carry the additional monitoring and enforcement responsibilities, and "a lot more spending on technology."

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