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White House submits bill on derivatives

By Marcy Gordon
Associated Press / August 12, 2009

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WASHINGTON - The Obama administration yesterday sent Congress legislation seeking to impose broad oversight on derivatives, the complex financial instruments blamed for hastening the global economic crisis.

The plan is designed to bring transparency to - and prevent manipulation in - a $600 trillion unregulated worldwide market. Credit default swaps, a form of insurance against loan defaults, account for about $60 trillion of that market. The collapse of the swaps brought the downfall of Wall Street banking house Lehman Brothers Holdings Inc. and nearly toppled American International Group last fall, prompting the government to support the insurance conglomerate with about $180 billion.

In a point long awaited by the financial industry, the plan defines types of derivatives broadly in a way it says will be “capable of evolving with the markets.’’

The plan sent to Capitol Hill was the final section of the administration’s sweeping legislative proposal for overhauling the US financial rule book to help avert a repeat of the meltdown touched off last year. It capped a series of measures rolled out in recent weeks by the Treasury Department.

Under the proposal, the big investment banks that trade the derivatives would be subject to requirements for holding capital reserves against risk and other rules. A new network of clearinghouses would be established to provide transparency for trades in credit default swaps and other derivatives. All so-called standardized derivatives would be required to go through clearinghouses and to be traded on regulated exchanges or electronic trading systems.

Customized derivative products, by contrast, are designed for specific users in a transaction and would remain largely unregulated - a gap that some critics fear could allow abuses.

The plan defines standardized derivatives broadly. An over-the-counter derivative that is accepted by an official clearinghouse would be presumed to be standardized. In addition, the Securities and Exchange Commission and the Commodity Futures Trading Commission would get authority to prevent attempts by market players to falsely portray derivatives as customized to skirt the oversight of clearinghouses and exchanges.

CFTC chairman Gary Gensler recently estimated that about 80 percent of derivatives could be considered standardized under the plan.