Mr. Geithner, in a letter to Senate Agriculture Committee Chairman Blanche Lincoln (D., Ark.), said new financial rules must create restrictions on how over-the-counter derivatives are traded "in order to curb abuses that were at the very center of the financial crisis." But he notably stopped short of endorsing a proposal from Ms. Lincoln to force large banks to spin off derivatives trading businesses entirely.
His letter is the latest in a forceful push by the Obama administration to counter a lobbying effort by financial companies to scale back the derivatives rules.
Mr. Geithner's two-page letter also could be an attempt to steer Ms. Lincoln's bill away from one of its most controversial elements – a requirement that large U.S. banks completely spin off their derivatives trading businesses. While he doesn't address this requirement in his letter, he does specify the exact requirements White House officials believe would accomplish tighter derivatives trading requirements. That could give Democrats cover to scale back her proposal while still toughening rules.
Some Democrats are worried that her proposal might be so controversial it could imperil the broader chances of the bill's passage, people familiar with the matter said.
Sen. Judd Gregg (R., N.H.) said in an interview Thursday that Ms. Lincoln's bill was "about as far 'left' as you could get on the issue of derivatives."
Ms. Lincoln and her Republican counterpart on the panel, Sen. Saxby Chambliss of Georgia, broke off negotiations over a possible bipartisan deal several days ago under pressure from the Obama administration to toughen the derivatives legislation.
Instead of an industry-friendly bill, which many were expecting, she is drafting a much more restrictive bill, people familiar with the legislation said.
Derivatives are a complex part of the financial system that exploded in popularity over the last decade. These products allow companies to essentially buy insurance against commodity prices, currency and interest rates. But they can also be used to place speculative bets, and banks make billions of dollars from trading and taking speculative bets on derivatives, which is one of the main reasons for the crackdown. Five of the biggest U.S. financial firms, including J.P. Morgan Chase & Co. and Goldman Sachs Group Inc., made more than $20 billion trading derivatives in 2009.
Mr. Geithner's letter, reviewed by the Wall Street Journal, says all over-the-counter derivatives dealers and "major derivatives market participants must be subject to substantial supervision and regulation," which includes capital and margin requirements, and "strong business conduct standards."
That statement touches on a flashpoint in the debate about derivatives regulation, which is determining how exactly to define "major derivatives market participants." Many companies want to be carved out of that definition, but White House officials and Ms. Lincoln have said they want to make it difficult to be exempt. Still, they have suggested manufacturing and agriculture companies that use derivatives for hedging purposes could be excluded.
Mr. Geithner's letter says standard derivatives contracts must be traded on "regulated exchanges or other regulated and transparent trading platforms." He also says standard derivatives contracts must be cleared through "well-regulated central counterparties," which he says "would directly reduce the complex web of bilateral connections between major financial firms."
People familiar with Ms. Lincoln bill said it goes far beyond the limits the Obama administration is pushing for. Her bill, which hasn't been unveiled and is being closely held, would force banks to spin off their derivatives trading businesses and force almost all standard derivatives to be traded on exchanges. It would also have new reporting requirements that would disclose details about the financial instruments.
Agriculture and manufacturing firms could win exemptions from certain requirements, but it would be more difficult than a lot of companies had hoped, people familiar with the matter said. Republicans and many financial companies have sharply criticized Ms. Lincoln's move, saying it could shut off access to credit and make it harder for companies to create jobs. She has said it would provide much-needed transparency to these products and protect the financial system from dangerous risks.
Ms. Lincoln's committee could hold a vote on her bill next week and then her measure could be added as an amendment to the broader financial overhaul when the package comes to the Senate floor.
Financial companies are lobbying aggressively against many of the provisions, as derivatives trading represents a major profit engine for them. A large number of bankers and corporate treasurers from dozens of companies are expected to descend on Capitol Hill next week and warn against some of the limits on derivatives Democrats are proposing.