Wednesday, March 31, 2010

Senator Brown Seeks Analog to Lynch Amendment on Derivatives Clearinghouses for Senate Financial Reform Bill

There has been concern that, with derivatives trading required to be conducted through clearinghouses, large financial institutions would own and control the clearinghouses and effectively set rules for their own derivatives deals. The Lynch Amendment to the House financial reform legislation prevents large financial institutions and major swap participants from taking over these new clearinghouses by imposing a 20-percent-voting-stake limitation on ownership interest in those institutions and the governance of the clearing and trading facilities.

The Lynch Amendment specifically provides that these restricted owners, which are defined as swap dealers, security-based swap dealers, major swap participants and major security-based swap participants, cannot own more than a 20 percent voting stake in a derivatives-clearing organization, a swap-execution facility, or a board of trade. Further, the rules of the clearing organization, swap-execution facility and board of trade must provide that a majority of the directors cannot be associated with a restricted owner.

Senator Sherrod Brown (D-OH) has been trying to get a similar amendment added to the Senate financial reform bill. Senator Brown, a member of the Banking Committee, failed to get the amendment added to the bill during the committee’s markup. It is now quite likely that he will try to add it as a floor amendment, which is when the Lynch Amendment was added to the House bill.

The Brown Amendment would require the CFTC and SEC to adopt rules related to conflicts of interest in ownership of the clearinghouses that set terms for derivatives trades. It would restrict shareholder ownership of a clearinghouse by the large financial institutions to 20 percent, separately or in aggregate. It would also prohibit large financial institutions from controlling a majority of the board and would require rules for self-dealing. According to Senator Brown, this would help prevent large financial institutions from setting their own rules for their derivatives trades and from tilting the playing field in their favor.