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Trade Groups Seek More Limited Plan to Regulate Derivatives Market

By Brady Dennis
Washington Post Staff Writer
Wednesday, October 7, 2009

An alliance of business trade groups is pushing to scale back the Obama administration's efforts to regulate the multitrillion-dollar derivatives industry, arguing that the proposed changes could have consequences well beyond Wall Street.

While government officials are seeking to rein in the excesses that contributed to the financial crisis, business lobbyists have been warning key lawmakers that companies such as Ford, Johnson & Johnson and Coca-Cola could suffer if the new regulations are far-reaching.

Beyond Wall Street, many companies have traditionally bought derivatives as a way to hedge against investment risks. It is those "end users" that the alliance wants excluded from the coming legislation.

In the lead up to the financial crisis, trading in derivatives -- securities that derive value from underlying assets, such as stocks, bonds and commodities -- swelled into an immense global market, accounting for hundreds of trillions of dollars in deals. Often dubbed the "shadow market," it allowed unregulated traders around the world to influence and speculate on a vast array of sectors, from how much companies pay to borrow money to the value of currencies and goods such as oil and cotton. Ultimately, derivatives acted as a catalyst in the downward spiral of the economy, and contributed to the meltdown of such financial giants as American International Group.

The ensuing debate about which firms to regulate in the vast, previously unregulated derivatives market has sparked a fervent lobbying effort on Capitol Hill in recent months. In August, the Obama administration proposed that most derivatives be traded on exchanges, like stocks and bonds, and that dealers -- primarily large Wall Street banks and other financial firms -- that buy and sell derivatives should meet robust requirements.

The Coalition for Derivatives End-Users, organized by groups such as the U.S. Chamber of Commerce, the Business Roundtable and the National Association of Manufacturers, sent a letter to lawmakers last week saying that "some reform proposals would place an extraordinary burden on end-users of derivatives in every sector of the economy -- including manufacturers, energy companies, utilities, healthcare companies and commercial real estate owners and developers." The letter was signed by more than 170 companies and trade associations.

"We definitely think the administration's proposal went too far," said Ryan McKee, senior director of the Chamber's Center for Capital Markets Competitiveness. "End users were not part of the problem. They don't pose systemic risk. They are not profiting from these transactions. They are not speculating."

Wall Street firms such as J.P. Morgan Chase and Goldman Sachs, which have profited over the years from dealing in derivatives, have waged lobbying efforts along with industry groups, such as the International Swaps and Derivatives Association, to reshape parts of the proposed legislation.

Legislation being considered by Rep. Barney Frank (D-Mass), chairman of the House Financial Services Committee, would exempt many end users from new rules and collateral requirements applying to the financial firms that underwrite many derivative contracts.

Still, while many lobbyists argue that the administration's initial plan went too far, others have said it might not go far enough. Gary Gensler, chairman of the Commodity Futures Trading Commission, has warned lawmakers that provisions of the administration's proposed legislation could leave significant elements of the derivatives market out of regulators' reach and undermine efforts to combat fraud.

William K. Black, a professor of law and economics at the University of Missouri at Kansas City who has previously testified before Congress about derivatives, said that those not traded on exchanges are overwhelmingly used to speculate, rather than to hedge. That can make markets inefficient and unstable, and he said the solution is to require disclosure of transactions and to limit derivatives to those that can be traded on formal exchanges.

Frank's committee scheduled a hearing Wednesday on reforming the derivatives market. Gensler is scheduled to testify, along with a Securities and Exchange Commission official, and representatives from the business and financial industries. The committee plans to approve a derivatives bill next week.

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