WASHINGTON -- Swaps trading would be freed from legal ambiguity by a rule the Commodity Futures Trading Commission aims to write by yearend, its top lawyer said.
The rule, asserting the power to exempt swaps and other derivative products from commission rules, would implement legislation passed last week. President Bush is expected to sign it.
"It's a brave new world," said Joanne Medero, the commission's general counsel.
The swaps provisions are part of a package to reauthorize the Commodity Exchange Act through fiscal 1994 and strengthen the commission's power to regulate futures.
Currently, the commission has authority to declare that a particular swap, forward, or similar derivative product is a future and therefore can be traded only on futures exchanges. But clear authority is lacking to do the reverse: exempt a product from regulation as a futures product.
The commission did issue a policy in 1989 stating that derivatives generally should not be regulated as futures, and that it would not act against a swap product that met a certain criteria.
However, that pronouncement has not provided the legal foundation for swap trading that dealers have sought. In court cases, products have been challenged on the ground that their being traded outside of futures exchanges was illegal.
Congress' granting of exemptive authority to the futures commission is expected to help considerably in providing that foundation, said Capitol Hill aides and lawyers in the field.
"The idea is that there would be a class exemption of some sort," said Ms. Medero. Those unsure whether their product fit the exemption could get informal advice from the commission, she said. "If you are confident you don't fit, you could ask on a case-by-case basis for a separate exemption."
Though the law would bolster the swaps industry, it could also bring new competition for swaps dealers. Even though the commission could exempt derivatives from regulations as futures, the bill would for the first time let futures exchanges trade the products.
The legislation would apply to municipal swaps, forwards, and other products as well as to their corporate counterparts. It would grant the new authority to the futures commission for only two years and would authorize several studies in the rapidly growing swaps area.
The bill is "the culmination of a four-year process," said Mark Mitchell, a partner and head of the futures department at the Chicago law firm of Chapman & Cutler. "We now have a greater certainty for a wide range of off-exchange instruments, including swaps.
"The industry looks forward to prompt action," Mr. Mitchell said.
Futures Commission Chairman Wendy Gramm said: "The bill gives needed legal certainty for swaps and other new derivatives. It gives our regulators flexibility to respond promptly and appropriately to changes in the marketplace.
"The flexibility - leaving enterprises free to excel and to innovate - is at the heart of good government. This bill will help America keep its status as the world leader in financial engineering."
To be eligible for an exemption under the bill, an applicant would have to show that trading in the product was limited to sophisticated participants that meet minimum financial strength criteria.
"This is an important step to reduce risk in the financial system," said Mark Brickell, a vice president at J.P. Morgan & Co. in New York and a director of the International Swap Dealers Association.
"It gives the CFTC power to eliminate legal risk associated with swaps in the U.S. It makes the financial system safer and increases the prospects for financial innovation. And it boosts the competitiveness of American participants in swap activity."