The march towards comprehensive regulation of the over-the-counter (“OTC”) derivatives market continued over the past month with the release of discussion drafts of the Over-the-Counter Derivatives Markets Act of 2009 by each of the House Financial Services Committee on October 2nd and the House Agriculture Committee on October 9th. The former discussion draft was approved by the House Financial Services Committee, with some amendments, on October 15, 2009 (as approved, the “Financial Services Proposal”). An “Amendment in the nature of a substitute” to the Financial Services Proposal was then introduced and approved by the House Agriculture Committee, with some amendments, on October 21, 2009 (as approved, the “Agriculture Proposal”).[1] Although the two proposals are similar in many respects to each other and to the Obama Administration’s initially proposed legislation (the “Treasury Proposal”), which was released in August 2009, there are significant differences between them, and between each of them and the Treasury Proposal.
Similar to the Treasury Proposal, the Financial Services Proposal and the Agriculture Proposal would largely divide regulatory authority over OTC derivatives between the Commodity Futures Trading Commission (“CFTC”), generally covering “swaps,” and the Securities and Exchange Commission (“SEC”), generally covering “security-based swaps.” However, one key difference among them is the definition of “major swap participant,” which under each of the proposals is generally defined to include non-swap dealer entities that maintain a substantial net position in outstanding swaps.
Under the Treasury Proposal, this definition is quite expansive, with a narrow exception for swaps used to create an effective hedge under generally accepted accounting principles (“GAAP”). However, the Financial Services Proposal version of this definition would disregard positions held primarily for hedging, reducing, or otherwise mitigating commercial risk. It also would include as major swap participants entities that are systemically significant (i.e., entities whose outstanding swaps create substantial net counterparty exposure that would expose counterparties to significant credit losses that could have a material adverse effect on capital of the counterparties).[2] After discussing and amending its discussion draft, the House Agriculture Committee defined “major swap participant” in the Agriculture Proposal in a similar, but not identical, manner.
Many other differences exist among the three proposals (including in connection with security-based swaps), some of which are highly technical in nature. The Financial Services Proposal and the Agriculture Proposal must now be reconciled into a single bill to be voted upon by the full U.S. House of Representatives. We will, of course, continue to monitor and keep you informed of legislative developments in connection with the proposed regulation of OTC derivatives.
[1] Note that the House Agriculture Committee had also approved the Derivatives Markets Transparency and Accountability Act of 2009 in February 2009. For a discussion of this proposed legislation, see the August Derivatives Month in Review.
[2] Note that this was a significant addition to the original House Financial Services Committee discussion draft, which would have disregarded for purposes of the definition of “mayor swap participant” positions that are “held primarily for hedging (including balance sheet hedging) or risk management purposes.” Following the release of this discussion draft, Administration officials and others argued that such an exemption would allow too many entities, even those that may be systemically significant, to evade regulation.