The head of the Commodity Futures Trading Commission (CFTC) has called on Congress to eliminate clearing exemptions and toughen language in the Obama administration’s legislative proposal for regulatory reform of the over-the-counter (OTC) derivatives markets and dealers.

“I believe the law must cover the entire marketplace without exception,” CFTC Chairman Gary Gensler said, 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).

“This excludes a significant class of end-users from the clearing and mandatory trading requirement. This major exception may undermine the policy objective of lowering risk through bringing all standardized OTC derivatives into centralized clearing,” Gensler wrote to Senate Agriculture Chairman Tom Harkin (D-IA) and and Sen. Saxby Chambliss of Georgia, the ranking Republican on the panel.

To address this concern, Gensler recommended that nonfinancial participants be allowed to establish a client relationship with a clearing member who would then clear the transactions in a client account on behalf of the commercial party. He went a step further and recommended that end-users be permitted by regulators to use noncash collateral to satisfy their margin obligations in appropriate circumstances. End users and producers had objected to being included because they might have to cash in assets or commodities to satisfy clearing credit requirements.

Gensler said he was also concerned with the Obama legislation’s broad exclusions for foreign exchange swaps and foreign exchange forwards from the definition of a “swap” subject to regulation by the CFTC. Specifically, he said the exclusions could enable swap dealers and participants to structure their swap transactions in such a way to come within these foreign exchange exclusions and thereby avoid CFTC regulation.

As an alternative to these exclusions, he recommended that the “foreign exchange swap exclusion should be stricken so that all swaps are covered by [Obama’s] proposed OTC Act; and [that] an appropriately tailored exclusion for foreign exchange forwards…be adopted.”

This “narrower exclusion for foreign exchange forwards should not apply to transactions involving retail customers; be explicitly tied to the anti-evasion rulemaking authority provided to the CFTC and the Securities and Exchange Commission (SEC); and require compliance with the transparency and business conduct provisions of the proposed OTC Act,” he said.

Gensler also recommended repealing the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), which permits banks and certain foreign clearinghouses to clear OTC derivative instruments. “Retaining [the FDICIA provisions] could create a situation where banks and foreign clearinghouses could clear swaps outside this new regulatory structure and be subject to potentially lesser standards,” he said.

Gensler’s proposed changes “largely seek to toughen the administration’s proposal and bring more transactions under a regulatory umbrella…His primary recommendation is to reduce the exceptions for transactions exempted from the new regulatory regime…Our view is that Gensler’s comments will be embraced by the Left and may hike the partisanship of the debate over the near term,” said energy analysts Teddy Downey and Chris Krueger of Washington Research Group (WRG).

Congress is seeking to walk a fine line in the OTC regulatory debate, said the WRG analysts. “If regulation is too tough, transactions would likely be driven overseas. From our standpoint, Gensler’s position seems like it might cross that fine line into regulation that is too aggressive, and it remains to be seen if his position will be embraced by lawmakers,” they said.

The Obama administration legislation on regulatory reform, which was sent to Capitol Hill earlier this month, calls for all standardized OTC derivatives, including energy transactions, to be centrally cleared; requires higher capital and margin requirements for nonstandardized derivatives; extends the scope of regulation to include OTC derivative dealers and major market participants; and gives the CFTC and the SEC stricter enforcement authority, and the power to set position limits and large trader reporting requirements for OTC derivatives (see Daily GPI, Aug. 12).

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