In Surprise, Frank Seeks Tougher Derivatives Bill

WASHINGTON — House Financial Services Committee Chairman Barney Frank unexpectedly sought Wednesday to toughen a bill to regulate derivatives, pushing an amendment that would require many major financial institutions to trade their derivatives contracts over exchanges.

If enacted, the amendment, which is expected to be voted on Thursday morning, could severely curb bank profits on derivatives — a prospect that left several large bank lobbyists scrambling Wednesday.

Though the banking industry had opposed the bill, Frank's measure had been considered the most acceptable of the three alternatives to derivatives regulation being considered on Capitol Hill.

But, responding to concerns raised by regulators last week, Frank said Wednesday that swap dealers and major swap participants must have their contracts exchange traded in addition to being cleared.

"If they are accepted for clearing, they've got to be traded on an exchange, if they are between financial institutions," Frank said of the derivatives contracts.

Since most derivatives contracts are confidential, banks and other derivatives dealers do not reveal the price they charge end users. But if the contract is cleared through an exchange, there would be greater price transparency — putting competitive pressure on dealers and potentially cutting into their profits.

Industry representatives argued Wednesday that such a requirement was pointless.

"We do not believe mandating exchange trading is necessary," said Cory Strupp, the managing director of the Securities Industry and Financial Markets Association, responding to news of the amendment. "There is no reason for the government to mandate one particular transaction mode over another."

But Frank said during the debate on the bill that the amendment was a good compromise. Smaller firms, known as end users, who use derivatives to hedge their risk and claim they cannot meet margin and collateral requirements posed by clearing houses and exchanges, would be exempted from clearing and exchange trading. But the Obama administration would achieve a major goal by having larger firms do both, providing greater transparency to the derivatives market.

"We do think we've got a reasonable proposal here that accommodates both interests," Frank said.

The switch was also supported by the administration.

"It's absolutely essential that the chairman's amendment gets passed," said Michael Barr, the Treasury assistant secretary for financial institutions, during a conference call with reporters.

Republicans balked at the change, but it was unclear if they could win enough support from moderate Democrats to stop it.

"This is a fundamental groundswell movement different from where we were just five days ago," said Rep. Scott Garrett, R-N.J., who had earlier praised Frank's draft bill as having moved "in the right direction" on the issues of mandatory clearing and exchange trading.

Rep. Spencer Bachus, the panel's lead Republican, said "you don't have to put them on an exchange to make them transparent."

So far, there appears to be sufficient support among business-friendly Democrats to approve Frank's changes.

"I very much support this amendment and urge the committee to adopt it," said Rep. Walter Minnick, D-Idaho.

"By ensuring to the extent possible that these transactions are regulated by an exchange, that there is adequate capital, that there is adequate disclosure and there is adequate information to regulators with regard to systemic risk," regulators could avoid another collapse of a big derivatives trader such as American International Group Inc., he said.

The committee is set to vote on the amendment and the full bill Thursday.

Debate over the legislation fell mainly along partisan lines, but there were some exceptions.

Rep. Shelley Moore Capito, R-W.Va., spoke out in favor of an amendment introduced by Rep. Stephen Lynch, D-Mass., that would limit ownership and control of clearing houses by dealers, dealer affiliates and major swap participants.

Lynch's amendment would have prevented swaps dealers from taking more than a 20% stake in clearing platforms. "There's a lot of incentive in there for them to try to dominate these clearing houses," he said, because it was in the interests of dealers to have a say in whether the derivatives they are selling have to be cleared or can be traded individually.

Garrett said the amendment went too far, but Capito disagreed.

"What this amendment is trying to get to is the greater transparency that I think we all want and the lessening of systemic risk," she said. "I believe that a small number of firms could and would dominate these clearing houses."

Several amendments passed on voice votes. One was Frank's revised definition of "major swap participant," which would widen the carve-out for end users to avoid clearing derivatives. Under the change, a major swap participant is a firm that not only takes large net positions but creates large exposures for counterparties by speculating in derivatives trades rather than using them to hedge.

At several points, Frank indicated that final derivatives legislation could drift into next year. At one point he speculated that a six-month implementation period in the bill could put the deadline for compliance with new laws at some point near the beginning of July.

After the hearing, he told reporters that his committee's bill, including some of the proposed amendments, took its stance closer to the one defined by the House Agriculture Committee's recent draft legislation on derivatives.

"There will be some harmonization between ourselves and Agriculture," Frank said, "but there are not major differences now as I understand it."

Though the exchange-trading requirement appeared to be a concession to criticisms the Obama administration made of Frank's bill, it did not go far enough for some. Michael Greenberger, a professor at the University of Maryland Law School, said the change was a small one. "It's only a baby step toward what Obama promised in his white paper which, is that all standardized products would have to be exchange traded," Greenberger said.