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Tougher Rules on Derivatives Gets Greenlight from Senate Panel

Posted on 22 Apr 2010

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A crack appeared on Wednesday in the Republican wall of opposition to the financial reform bill. A Republican senator, Charles E. Grassley of Iowa, voted Wednesday in favor of a measure requiring tough regulations on the market for derivatives, the complex financial instruments that were behind much of the breakdown in financial markets two years ago.

He was the lone Republican to side with Democrats on the Agriculture Committee in approving a bill that will now be folded into the larger financial overhaul measure.

Mr. Grassley, who is up for re-election this year, said in a statement that his vote did not mean that he would support the larger bill, which he noted had “a number of flaws that need to be resolved before I’d support it.”

Nevertheless, his decision to side with the Democrats underscored the potential political peril for Republicans in opposing tighter rules for Wall Street, at a time of public frustration over the return of huge earnings and blockbuster bonuses even as unemployment remains high and recovery limps along in much of the country.

The Agriculture Committee voted 13-8 to approve the bill, which was sponsored by Senator Blanche Lincoln of Arkansas, the committee chairwoman. The bill would require most derivative contracts to be traded on a public exchange and to be processed, or cleared, through a third party to guarantee payment if one of the traders went out of business.

It also would require most big banks and Wall Street firms to put their derivatives trading business into a separate subsidiary, a move opposed by the banks as well as the Obama administration.

Senate Republicans have said that they wanted to toughen the overall rules for Wall Street, the lack of which led to big bailouts when the financial markets tumbled in 2008. But they say that the Democrats’ legislation leaves loopholes that would allow future taxpayer-financed bailouts of big banks.

In recent days, however, Republicans have suggested that bipartisan negotiations have restarted and have begun to yield progress, though Democrats have not announced any major changes to the legislation.

Mr. Grassley said part of his decision to support the derivatives bill came because it offered regulators the ability to tell more quickly what is happening in the derivatives market, which is largely unregulated, with trades occurring directly between firms with no reporting of prices or volume.

“I voted for the chairman’s derivatives bill today because I think transparency is the right policy,” Mr. Grassley said. “The draft isn’t perfect, and I want to fix the way a provision is written so that whistle-blower protections are not weakened as a result, for example. But the Lincoln bill is an important step in the right direction for transparency and accountability in the derivatives market.”

Separately on Wednesday, some liberal Senate Democrats introduced legislation seeking to limit the size of the nation’s biggest banks — a more aggressive step than many lawmakers have been willing to take in reining in the most complex financial institutions.

Republicans on the Agriculture Committee complained on Wednesday that months of efforts to develop a bipartisan bill had been upended by Senator Lincoln in moves they said came partly at the instigation of the White House.

But Mrs. Lincoln, who faces a tough re-election campaign this year, said there was urgent need to shine light on the trading of derivatives, complex financial instruments tied to the movement in prices of commodities, stocks or other underlying assets. She said she never heard from the White House or the Treasury secretary about her bill.

In approving the bill, the committee decided to allow for an exemption of derivatives that are used to hedge against movements in foreign currency exchange rates. The exemption would depend on a written determination by the Treasury secretary that so-called foreign exchange swaps should be exempted, according to a staff review of the amended bill.

Mrs. Lincoln said Wednesday morning that she decided to make the change after talking with senators in both parties as well as some companies that use foreign-exchange derivatives to protect against swings in the value of profits earned in overseas operations.

The Treasury Department has indicated that it could support some exemptions in the derivatives coverage for certain commercial end users — typically businesses that trade derivatives in order to protect their operations from swings, for instance, in the cost of fuel or other raw materials.

“This bill is surgical in its approach,” Mrs. Lincoln said in her opening statement. “We have an important but narrow end user exemption, appropriate restraints on the regulator where necessary, and provisions that recognize we are competing in a global financial world.”

Senator Saxby Chambliss of Georgia, the senior Republican on the committee, said there was unanimous agreement among lawmakers and Treasury officials agree that “there needs to be 100 percent transparency.”

But he said that he believed the bill would drag institutions like community banks and special agriculture banks under the stiff regulations, hurting their business even though it is not related to the transactions that helped to being about the financial crisis.

“All of a sudden they are going to be treated like Goldman Sachs or those major firms on Wall Street,” Mr. Chambliss said.

The agriculture panel has jurisdiction over the Commodity Futures Trading Commission, which has oversight over derivatives tied to commodity prices.

Gary Gensler, the chairman of the commission who answered questions at the committee mark-up, said that he disagreed and that community banks would not be treated like big banks under the bill. But its trades with those banks would need to be routed through a clearinghouse, he said, to protect the small bank if the big bank went out of business.