Senate reform bill to capture more end-users in OTC clearing requirement

The 1,336-page Restoring American Financial Stability Act contains a definition of a major swap participant that is markedly broader than that contained in the bill passed by the House of Representatives in December 2009.

The determination of whether a firm constitutes a major swap participant dictates whether they will be required to centrally clear all derivatives trades, save foreign exchange options and forwards, which are exempt.

Under the legislative language published yesterday, a major swap participant is defined as “any person who is not a swap dealer and who maintains a substantial net position in outstanding swaps, excluding positions held primarily for hedging, reducing or otherwise mitigating commercial risk; or whose failure to perform under the terms of its swaps would cause significant credit losses to its swap counterparties”.

In contrast, the definition agreed in the House of Representatives bill is far stricter, requiring that a counterparty must hold "outstanding swaps that create substantial net counterparty exposure that could have serious adverse effects on the financial stability of the US banking system or financial markets” to qualify as a major participant and face central clearing.

The Senate bill also includes prohibitions against proprietary trading and ownership or sponsorship of private equity or hedge funds, announced by the Obama administration in January.

Despite expectations that Banking Committee chairman Christopher Dodd would not insert the contentious injunctions into the legislation, proprietary trading is defined almost exactly as the administration specified it should be: any trading in stocks, bonds, options, commodities, derivatives or other financial instruments by insured depository institutions is prohibited, unless it is done on behalf of a customer, or as part of market-making, hedging or otherwise in the facilitation of customer relationships.

US Treasury secretary Timothy Geithner called the legislation “a strong bill” and vowed to “strengthen the bill and fight against efforts to weaken it”, while Spencer Bachus, the leading Republican on the House Financial Services Committee, was quick to denounce it.

“If the Senate is serious about meaningful financial reform, they will focus on the areas that caused the crisis in the first place and commit to ending the bailouts, terminating the Troubled Assets Relief Program, and keeping the government out of picking winners and losers. It is crucial that we get bank supervision right, but this Senate plan gets it wrong. The Fed needs to first focus on monetary policy without taking on further responsibilities that could distract them from their primary role,” Bachus said.