On Friday, Congressman Barney Frank (D-MA), Chairman of the House Financial Services Committee, released a discussion draft of proposed legislation to strengthen the regulation of the over-the-counter (OTC) derivatives market. The proposed legislation largely reflects the principles outlined in the concept paper jointly released by Congressmen Frank and Congressman Collin Peterson (D-MN), Chairman of the House Committee on Agriculture, a few months ago.

Under the discussion draft, derivatives swaps would be exempted from rules requiring centralized clearing if “one of the counterparties to the swap is not a swap dealer or major market participant,” though such transactions would be required to be reported to regulatory authorities. This is an important trading exemption which would relieve end-users of derivatives products, such as companies that use derivatives to hedge their business operations, from being subject to strict trading requirements. The exemption also expands the Obama administration’s proposal to exempt end-users from collateral and clearing requirements. Under Frank’s proposal, end-users would be exempt from posting additional cash collateral for hedging transactions, and would instead be permitted to post non-cash items as collateral to satisfy margin requirements.

Furthermore, under the proposed legislation, the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) would be provided with authority to “prohibit transactions in any swap” that they determine “would be detrimental to the stability of a financial market or of participants in a financial market.” The CFTC would be given the further authority to regulate bilateral swaps in certain commodities and to set position limits on speculation that takes place outside of regulated exchanges. The CFTC’s authority also would be extended under the bill to reach certain foreign boards of trade (FBOTs) offering direct access to U.S. investors on any linked “agreement, contract or transaction,” whereby the FBOTs would be required to set position limits, release trading data and establish rules to prevent market manipulation and excessive speculation. In the event that the Securities and Exchange Commission (SEC) and the CFTC cannot agree on joint regulations regarding the treatment of economically-similar products and setting position limits, the Treasury Department would make the final decision. This provision differs from the principle articulated in the concept paper, which would have provided final authority to a new Financial Services Oversight Council.

The House Financial Services Committee will hold a hearing on regulation of the OTC market and this discussion draft on Wednesday, October 7.