Bill Seeks Curbs on Derivatives

WASHINGTON - The Treasury Department has sent lawmakers draft derivatives legislation that would prohibit municipalities that have less than $50 million in discretionary investments from participating in over-the-counter derivative transactions that are not centrally cleared or exchange-traded.

But it appears the draft legislation, which Treasury officials detailed yesterday in a conference call with reporters, would not expand the commission's existing anti-fraud authority over municipal-bond related interest rate swaps, according to sources.

The SEC is currently in a court battle with the Securities Industry and Financial Markets Association as well as the former head of the Jefferson County, Ala., Commission and an Alabama bond dealer over how far the commission's derivatives enforcement authority extends and whether the SEC can take enforcement action in connection with the county's municipal bond-related interest rate swaps.

The draft legislation was sent to the House and Senate committees with jurisdiction over derivatives and appears to be broader in some respects than the derivatives legislative proposals recently agreed to and released by House Financial Services Committee chairman Barney Frank, D-Mass., and House Agriculture Committee chairman Collin Peterson, D-Minn. Their proposals, which were only briefly outlined, did not address unsophisticated investors.

But Treasury deputy secretary Neal Wolin and assistant secretary for financial institutions Michael Barr told reporters that the administration wants to tighten the definition of eligible investors that are able to engage in OTC derivative transactions to better protect individuals and municipalities.

Specifically, the draft would amend the definition of "eligible contract participant" in the Commodity Exchange Act so that it would include a government or political subdivision that owns less than $50 million of discretionary investments.

Municipal market participants said they want to study the draft.

"It's a first-cut, broad-stroke measure to limit systemic risk related to the use and the overall use of derivatives," said Scott Fairclough, senior vice president and head of public finance derivatives at Sterne, Agee & Leach Inc. in New York. "It needs to be more defined."

"The vast majority of small municipalities should really be no where near the derivatives market," said Peter Shapiro, managing director of Swap Financial Group in South Orange, N.J. "But it has to be carefully defined to keep unscrupulous players out while not excluding those larger municipalities that have legitimate hedging needs."

Shapiro said using the level of a municipality's investments "may not be the right way, but there's nothing wrong with the concept of protecting small unsophisticated municpialities from making expensive mistakes" by engaging in derivatives they don't understand.

Like Frank and Peterson's proposal, the administration draft would try to push more OTC derivatives into becoming standardized by requiring that regulators set higher capital and margin requirements for non-standardized contracts. Standardized derivative contracts would have to be centrally cleared and traded over an SEC or Commodity Futures Trading Commission regulated exchange.

The SEC, CFTC, and banking regulators also would be given authority to prevent market participants from "spurious customization" to avoid central clearing and exchange trading.

The same three entities would have access, on a confidential basis, to information about OTC derivatives transactions and related open positions of individual market participants. The public would have access to aggregated data on open positions and trading volumes.

All derivatives dealers and those who take large positions in derivatives would be subject to federal regulation. The regulators also would have clear, unimpeded authority to deter market manipulation, fraud, insider trading, and other abuses in the OTC derivatives markets.

For reprint and licensing requests for this article, click here.
MORE FROM BOND BUYER