The Commodity Futures Trading Commission (CFTC) would acquire new oversight authority of over-the-counter (OTC) commodity swaps, as well as derivatives traded on foreign exchanges under draft legislation released Friday by Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee.

The committee is scheduled to hold a hearing on the matter Wednesday at which CFTC Chairman Gary Gensler is to testify. Provisions in the 187-page discussion draft would allow for regulation of bilateral swaps and limits on speculation that takes place outside of regulated exchanges.

“Lacking and lagging regulation of OTC derivatives was a major contributing factor to last year’s [financial] crisis, including the highly leveraged credit default swaps at AIG that prompted government intervention,” said Rep. Melissa Bean (D-IL), Financial Services Committee member and co-chair of the New Democrat Coalition’s Financial Services Task Force. “This bill moves us in the right direction by reducing risk to the economy with robust and dynamic oversight of major market participants, while preserving appropriate risk-management tools for end users.”

The legislation would affect entities such as United States Natural Gas Fund (UNG), an exchange-traded fund that invests in swaps. Limits intended to curb speculation by funds have prevented UNG from expanding its holdings in natural gas on the New York Mercantile Exchange and IntercontinentalExchange Inc. The limits have hindered the fund in offering new units to investors (see Daily GPI, Sept. 15).

“A year ago, many critics of derivatives were ready to eliminate the entire over-the-counter market. This reaction was unreasonable and not in the best interest of our economy. The Frank proposal addresses the systemic risk issues by mandating exchange clearing and trading for the majority of products while preserving the over-the-counter market for specialized contracts, in much the same way that the bill I introduced with the New Dems does,” said Rep. Michael E. McMahon (D-NY), member of the New Democrat Coalition.

A recent analysis by Deloitte & Touche LLP cautioned that regulatory reform could have the effect of reducing hedging options and market liquidity. If regulations aren’t harmonized across exchanges internationally, some U.S. trading could migrate overseas, Deloitte said (see Daily GPI, Sept. 18).

Last month Garry O’Connor, chief product officer for the International Derivatives Clearing Group LLC, told the House Agriculture Committee, “The OTC derivatives markets currently represent a greater risk to our underlying economy than they did before the financial crisis began, and new rules need to be put in place as soon as possible” (see Daily GPI, Sept. 21).

In late August Gensler called on Congress to eliminate clearing exemptions and toughen language in the Obama administration’s legislative proposal for regulatory reform of the OTC derivatives markets and dealers (see Daily GPI, Aug. 24).

“I believe the law must cover the entire marketplace without exception,” Gensler said at that time, adding he was concerned that the administration’s proposal would exclude from mandatory clearing and exchange trading of standardized swaps counterparties that are not swap dealers or major swap participants (and do not meet the eligibility requirements of any clearinghouse that clears the swaps).

The draft is available on the committee website.

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