House Financial Services Committee Approves Legislation Regulating OTC Derivatives Markets
The House Financial Services Committee has approved legislation that would, for the first time ever, require the comprehensive regulation of the over-the-counter (OTC) derivatives marketplace. The OTC Derivatives Markets Act of 2009 (HR 3795), which was approved by a vote of 43-26, represents a key part of a broader effort by Congress and President Obama to modernize America’s financial regulatory system in response to last year’s financial crisis
Introduced by Rep. Barney Frank, Chair of the Financial Services Committee, the legislation would mandate exchange clearing and trading for the majority of derivatives products, while preserving the over-the-counter market for specialized derivatives. The legislation is designed to implement the broad goals of the Obama Administration to increase transparency and eliminate systemic risk in the OTC derivatives markets while at the same time protecting end users seeking to hedge their risks and preventing much of the U.S. derivatives market from being forced overseas.
Three amendments to HR 3795, sponsored by Ranking Member Spencer Bachus were accepted by the committee. The Bachus amendments would extend the rulemaking implementation period of the legislation from 180 days to 270 days after enactment, provide the SEC and the CFTC with exemptive authority similar to current law; and prevent taxpayer funded bailouts of derivatives clearinghouses. All three amendments were accepted by voice vote.
Under the bill, all standardized swap transactions between dealers and large market participants, referred to as “major swap participants,” would have to be cleared and must be traded on an exchange or electronic platform. A major swap participant is defined as anyone that maintains a substantial net position in swaps, exclusive of hedging for commercial risk, or whose positions creates such significant exposure to others that it requires monitoring. OTC derivatives include swaps, which are contracts that call for an exchange of cash between two counterparties based on an underlying rate, index, credit event or the performance of an asset.
The legislation then sets out parallel SEC-CFTC regulatory frameworks for the regulation of swap markets, dealers, and major swap participants. Rulemaking authority is held jointly by the CFTC, which has jurisdiction over swaps, and the SEC, which has jurisdiction over security-based swaps. The Treasury Department is given the authority to issue final rules if the CFTC and SEC cannot decide on a joint approach within a certain time period. Subsequent interpretations of rules must be agreed to jointly by the Commissions.
The legislation provides a mechanism to determine which swap transactions are sufficiently standardized that they must be submitted to a clearinghouse. For transactions that are clearable, clearing is a requirement when both counterparties are either dealers or major swap participants. Clearing organizations must seek approval from the SEC or CFTC before a swap or class of swaps can be accepted for clearing. Transactions in standardized swaps that involve end-users are not required to be cleared. Such customized transactions must, however, be reported to a trade repository.
A standardized and cleared swap transaction where both counterparties are either dealers or major swap participants must either be executed on a board of trade, a national securities exchange or a swap execution facility, which is defined in the legislation. If none of these venues makes a clearable swap available for trading, the trading requirement would not apply. Counterparties would, however, have to comply with transaction reporting requirements established by the SEC or CFTC. The legislation also directs the regulators to eliminate unnecessary obstacles to trading on a board of trade or a national securities exchange.
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