Legislation that would require swaps and other over-the-counter derivatives to be traded on an exchange is overreaching and would thwart the use of the products to hedge risk, officials from two industry groups said Friday.

Representatives of the International Swaps and Derivatives Association Inc., the largest trade group for the privately negotiated derivatives industry, and the Securities Industry and Financial Markets Association were reacting to the Derivatives Trading Integrity Act, introduced Thursday by Sen. Tom Harkin, D-Iowa, to bring the massive over-the-counter, or OTC, derivatives market under federal regulation.

Harkin's bill would amend the Commodity Exchange Act to eliminate the distinction between derivatives traded over the counter and on an exchange. OTC swaps that are currently negotiated privately between two parties are exempt from regulation by the Commodity Futures Trading Commission. The bill would force these derivatives onto an exchange and under the regulatory authority of the CFTC.

"In effect, this means that all futures contracts must trade on a designated contract market or a derivatives transaction execution authority," Harkin said in a statement on the Senate floor.

But ISDA officials warned that Harkin's bill would be too restrictive.

"ISDA believes that a new regulatory framework for the financial services industry is critical to modernizing our approach to sophisticated products and markets," said Greg Zerzan, counsel and head of global public policy for ISDA. "However, requiring both on and off-exchange products to be subject to the same regulatory regime would mark a step away from that goal."

"In addition to the standardized contracts covered under the Commodity Exchange Act there will continue to be a need for customized, privately negotiated risk management solutions," he said. "Eliminating the ability of businesses and investors to use these products would hurt their ability to manage risks and weather tough market conditions."

The Commodity Futures Modernization Act of 2000 provided legal certainty for OTC swaps - effectively putting them outside the scope of regulation by the CFTC or the Securities and Exchange Commission. Harkin, who co-sponsored the 2000 bill, is seeking to overturn those provisions of the CFMA.

"The approach suggested by Harkin was rejected in the 1990s," said Travis Larson, a spokesman with SIFMA. "Harkin's bill effectively ends the OTC business."

Two companies, Chicago-based CME Group Inc. and Atlanta-based IntercontinentalExchange Inc., have offered to serve as exchanges for credit default swaps. CME announced in October a plan to be the clearing party for CDS contracts.

Allan Schoenberg, a spokesman with CME, said the company has been in talks with the CFTC, SEC, and the Fed and is waiting for regulatory approval to proceed with listing CDS contracts. IntercontinentalExchange declined to comment on Harkin's legislation.

A spokesperson for the Investment Company Institute said: "We support initiatives that would reduce counterparty risk in this area, and we're examining the ideas that are being considered relating to establishing a central counterparty for credit-default swaps."

The legislation is not likely to pass before the end of the year, sources said. Industry advocates said they expect Harkin to pick up the measure again in the 111th Congress when the bill might receive a more favorable response.

The SEC is expected to discuss efforts to promote OTC transparency when chairman Christopher Cox convenes the International Organization of Securities Commissions Technical Committee today.

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