House Leader Seeks SEC-CFTC Input as Derivatives Legislation Moves towards Passage

As the House anticipates floor debate on legislation regulating derivatives, Financial Services Committee Chair Barney Frank has asked the SEC and CFTC for input in crafting two important amendments to the legislation. In a letter to SEC Chair Mary Schapiro and CFTC Chair Gary Gensler, Mr. Frank said that he would clarify who can claim the exception from the clearing and trading requirement; and also place solely with the SEC and CFTC the decision on what swaps must be cleared. Specifically, the Frank Amendment would clarify the exception for end-users hedging legitimate business risks. The amendment is designed to make the exception tight enough to prevent speculators from masquerading as end users.

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.

There has been some concern over the scope of this end user exception and that it could be manipulated to avoid clearing. This concern would be alleviated by tightening the instructions the legislation gives the SEC and CFTC regarding the exception. Under the draft, there is no self-certification since the bill authorizes the SEC and CFTC to decide if the exception is proper. While the Chair is confident that the vigilance of the SEC and CFTC will prevent scheming firms from getting an exception they are not entitled to, legislative language further tightening the exception would also be useful.

There is also concern that a provision in the draft allowing a clearinghouse to decide if a trade can be cleared could be used by clearinghouses owned by financial firms to assert that swaps are not clearable and thus not required to trade on an exchange. The Frank Amendment would cure the problem by requiring the SEC and CFTC to decide is a trade is clearable.

The Lynch Amendment to the draft was designed to alleviate the problem by restricting a financial firm’s ownership stake in a clearinghouse to 20 percent. But the Agriculture Committee opposes the Lynch Amendment, citing a fear that it may result in an insufficient number of clearinghouses. But, even though his amendment would give the SEC and CFTC the power to decide clearability, the Chair still supports the Lynch Amendment because he believes it is important to reduce the stake that financial firms have in clearinghouses in order avoid conflicts of interest. Thus, he intends to reinsert the Lynch Amendment on the House floor.

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