Two US House chairmen back mandatory OTC clearing in derivatives reform goals

July 30, 2009

WASHINGTON, July 29 (Reuters) – Over-the-counter derivatives should go through central clearing and trade on regulated exchanges as much as possible, according to a paper prepared for release by the chairmen of the U.S. House of Representatives Financial Services and Agriculture committees. The paper, obtained by Reuters, is to be unveiled Thursday and is intended as a guide for legislation to be written after Congress returns from its August recess.

Major points in the paper are:

* OTC dealers, exchanges and clearinghouses would be regulated by either the Securities and Exchange Commission or the Commodity Futures Trading Commission based on whether the derivatives they handle are based on securities.

* Clearinghouses “will be robustly regulated.” Oversight of ICE Trust, a clearinghouse for credit default swaps (CDS), would shift from the Federal Reserve to the SEC.

* All OTC trades must be reported to a trade repository.

* Regulators must rule within 180 days of a request for approval of a clearinghouse, exchange or electronic trading platform.

* Derivatives must be traded on an exchange and go through clearing unless regulators decide the market for the derivative is too illiquid, the derivative is too customized for clearing or one party is an end-user who is not a “major market participant.”

* Regulators should have authority to prohibit transactions that are not traded on an exchange or cleared, and have the power to set standards for customized trades.

* Regulators will develop margin and capital requirements that will encourage dealers to trade derivatives on exchanges and go through clearing.

* “Significantly higher” capital and margin charges will apply to customized transactions that are not traded on exchange or cleared; lower capital and margins would apply to derivatives that are traded on exchange and cleared.
* Ban “naked” credit default swaps, or

* Require reporting of all short interest in CDS contracts by OTC derivatives dealers, investor funds that exceed $100 million and “major market participants.” Regulators would have power to impose position limits and “ban the purchase of credit protection using CDS by any non-dealer who is not hedging a risk.”

Naked CDS are those bought by parties who do not own the underlying asset, who do not run a risk that is protected by the CDS or is not a bona fide market maker.

* U.S. regulators to work with foreign regulators to harmonize regulation of OTC derivatives, including recognized international standards with respect to clearinghouses.

* Treasury Department will be authorized to restrict access to U.S. banking system for institutions from nations with lower capital standards or that promote “reckless” market activity.

* A Financial Services Oversight Council will be created to determine which agency has jurisdiction over new products and to resolve disputes over interpretation of commodities and securities law.

* Agencies would have enforcement authority over products under their jurisdiction and joint enforcement power over any products subject to joint jurisdiction.
(Reporting by Charles Abbott, Editing by Tim Dobbyn)

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