More Wiggle Room in New Derivatives Bill

WASHINGTON — A House Financial Services Committee version of a bill to regulate derivatives would allow banks and others more leeway to use derivatives for hedging purposes without sending them through a clearing house.

Under a Treasury draft of the bill submitted to Congress in August, all "end user" firms, including banks, would have to use a clearing house unless they could prove the derivative was being used to hedge against risk.

But industry representatives complained that the Treasury's requirements for proof were onerous, and would force most derivatives through a clearing house. The fear, they said, was that because of margin requirements set by clearing houses, most end users would stop using derivatives altogether, effectively drying up the market.

But the bill from Chairman Barney Frank, D-Mass., would allow more leeway to prove a derivatives contract was being written for hedging purposes.

"It's a significant liberalization," said Ernest Patrikis, a partner at White & Case LLP.

He said that while the Treasury's bill would have made end users adhere to a single, narrow accounting rule to prove they were using derivatives to hedge, the Frank bill lets them use less draconian measures of proof. Firms using derivatives to hedge now will not have to line up each trade one to one with a position on their books.

"I can hedge to my portfolio as opposed to a specific transaction," Patrikis said.

While Frank's bill is enjoying more popularity among industry participants than the Treasury's proposal did, big banks are still not likely to support it. Under the bill, they would still face clearing and exchange-trading requirements that observers say will hurt dealers' profitability.

Observers will get their first chance to gauge support for the bill during a hearing Wednesday in the House Financial Services Committee. Commodity Futures Trading Commission Chairman Gary Gensler is set to testify, among others.

Gensler may push Congress to be tougher. The Frank bill is more lenient than the CFTC's own recent proposals to rein in derivatives, though it does give the agency broad authority to write rules governing the derivatives markets.

So far the bill appears to be winning the approval of moderate Democrats. A press release put out late Friday by House Financial Services touted the support the bill has received from business-friendly Democrats. Rep. Melissa Bean, D-Ill., praised the proposal, and the New Democrat Coalition voiced its support.

But what remains unclear is the level of enthusiasm for the bill among members of the House Agriculture Committee, which oversees the CFTC. Frank and House Agriculture Chairman Collin Peterson, D-Minn., had earlier tried to work together on a single bill. On July 31 they released an outline of their joint legislation but said they still had details to settle.

More recently, Peterson had said he was working on his own derivatives bill, and in September the committee held hearings on derivatives regulation that included testimony from end users, exchange and clearing providers and regulators. Peterson repeatedly expressed mistrust of the end users' complaints.

"It's my impression that some of the big financial players have sent a bunch of these end users around to talk to you," he told Gensler and Securities and Exchange Commission Chairman Mary Schapiro during a hearing on Sept. 22.

"From what I can tell out of this," Peterson said of the clearing requirement, "this is actually going to cost those big guys money and actually save the little guys money."

A spokesman for the agriculture committee said Peterson did not yet have comments on the Frank bill.

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