By Zachary A. Goldfarb
Washington Post Staff Writer
Thursday, October 15, 2009
A House committee is set to vote Thursday on a bill that would regulate for the first time the vast and opaque market of exotic financial instruments known as derivatives, marking the first major advance in Congress of a key piece of legislation to remake the nation's financial regulatory system.
The legislation, which is widely expected to pass the House Financial Services Committee, signals that, after months of debate and lobbying, Congress is ready to move ahead on new rules to protect investors and avert another financial meltdown.
In a session Wednesday, the committee, led by Chairman Barney Frank (D-Mass.), worked to fix several problems with the legislation that federal regulators had warned could undermine efforts to improve oversight of derivatives. Still, regulators have expressed concern that flaws remain.
After the clearing the derivatives bill, the committee plans to take up a proposal to create a new agency that would protect consumers of mortgages, credit cards and other financial products. Frank wants both pieces of legislation to pass the House by year's end.
"Today's events indicate that the House . . . is well on the path toward comprehensive financial reform," said Michael Barr, assistant Treasury secretary for financial institutions.
The legislation would require banks and firms trading in derivatives to meet robust capital and reporting requirements and require that many of the instruments be traded through clearinghouses, which would collect data about the market and require that buyers and sellers allocate enough money to cover any trades.
The Senate is moving on a slower schedule and legislation isn't expected to reach the president until well into next year.
In just a few years, trading in derivatives -- which are essentially contracts between two investors betting on whether a stock, bond or other security will go up or down in value -- has mushroomed into the world's largest financial market, estimated to be in the tens of trillions of dollars. It has allowed unregulated traders around the world to influence and bet on a vast array of sectors, from how much companies pay to borrow money to the value of currencies and critical goods such as oil and cotton.
Losses on a type of derivative known as a credit-default swap helped topple American International Group and stoked the financial crisis.
The financial industry remains opposed to a key proposal likely to be added to the derivatives bill before the vote Thursday. The proposal would require that a large percentage of derivatives be traded on public exchanges, like stocks and bonds, which would provide public information about the pricing and volume of trades.
"Mandatory exchange trading is a matter of very deep concern for the industry," said Cory Strupp, the managing director for government affairs at the Securities Industry and Financial Markets Association. "It isn't appropriate for many derivatives and it raises transaction costs and doesn't reduce risk."
Some regulators in Washington have been proponents of regulating derivatives for years, but lawmakers and many other policymakers have resisted it, worried about stifling financial innovation.
In addition, the House Financial Services Committee and the House Agriculture Committee, which is expected to take up the measure next week, have squabbled over the issue, as have the Securities and Exchange Commission and the Commodity Futures Trading Commission, which would share responsibility for policing the market under the legislation.
Some experts worry that these divisions will continue to hamper regulation. "Will it be effectively regulated? Or will there still be this gap where it's not clear which agency will do what? Or will there be duplicative regulation?" said Roberta S. Karmel, a financial regulation expert at Brooklyn Law School.
The SEC has expressed deep concern that it wouldn't have authority to oversee a type of derivative under the new law that is linked to an index of securities, such as the Standard & Poor's 500-stock index.
The SEC has said these kinds of limitations have made it much harder to investigate potential financial wrongdoing.
The CFTC has expressed its own concerns -- for example about whether it will have sufficient power to oversee clearinghouses and exchanges.
The committee has worked to ease other concerns. For example, it listened to regulators' complaints that a draft of the bill exempted too many derivatives traders from rigorous oversight and broadened the types of firms that would be subject to regulation.
With minor adjustments, the measure is not expected to face many hurdles going forward. By contrast, the proposal to create a Consumer Financial Protection Agency has become the most divisive element of the administration's wide-ranging plan to overhaul the nation's financial regulatory system.
Frank already has scaled back the original scope of his legislation in an effort to reach consensus on the new agency. He said last month that he would exempt certain nonfinancial businesses from oversight by the new agency, including telephone and cable companies, auto dealers, lawyers, providers of certain retirement and pension plans, accountants and real estate brokers.
Perhaps the most contentious issue that remains involves a provision that would require all states to enforce more rigorous rules than the federal guidelines for consumer protection set by the new agency. Business and financial firms say that could lead to burdensome, costly regulation that could create state and federal conflicts.
Staff writer Brady Dennis contributed to this report.