Derivatives Provisions in FinReg Under Fire

The U.S. Senate passed the financial reform bill last Thursday, though I'm not sure that there are any champagne corks popping on Wall Street. Though some bankers are reportedly relieved that the measures aren't as Draconian as they could have been, the bill reigns in OTC derivatives, threatens proprietary trading desks and forces hedge funds to register with the SEC.

Surprisingly, with all the media spotlight on financial industry lobbying to water down certain measures, the final bill passed in the senate is tough on derivatives. "The bill does have teeth, probably more teeth, than it had a few weeks ago," observed Andrew Ross Sorkin of the New York Times in an indepth interview with Charlie Rose about Financial Regulation Reform.

On the other hand, Steven Pearlstein of The Washington Post, told Charlie Rose in the same interview, that Wall Street is putting on a public show of how terrible the bill is. The industry doesn't like the provisions about derivatives, about directors and about rating agencies. But Pearlstein said, "The truth is that it could have been a lot worse and behind closed doors, I think they're actually popping champagne corks."

Both journalists seem to agree that the most significant provisions are the ones affecting derivatives - in terms of requiring them to trade on open exchanges, post collateral via clearinghouses and gain transparency.

"The Volcker Rule is significant and the derivatives rule is significant," said Sorkin, referring to the rule that would prohibit banks from doing proprietary trading and not allow them to own hedge funds or private equity units. "And by the way it is going to be the next fight," said Sorkin. The battle is not over yet because the Senate bill passed has to be reconciled with the House bill that was passed in December. One of the "bigger distinctions between the bills is over derivatives and whether banks with FDIC insurance and access to the discount window can also play in the derivatives and swaps markets. The current Senate bill says No, to that, noted Sorkin.

The question is whether the financial industry will be successful in persuading Congress to drop the provision inserted by Sen. Blanche Lincoln requiring banks to spin out their derivatives operations. Sorkin points out that the Administration and Treasury Department headed by Secretary Tim Geithner as well as Sheila Bair of the FDIC, are supporting Wall Street in saying the component on derivatives isn't right.

"The question is whether big banks are allowed to be in the derivatives business and the Administration is oddly on the bank's side," noted Sorkin. But the Post's Pearlstein, argued this support is not odd. He argued that the Administration has sided with the financial establishment all along throughout this process, since it defended the Federal Reserve against criticism that it fueled the housing bubble with cheap credit and yet it has come out with more power.

Pearlstein contends that the Administration has been friendly to the street because the big banks were not broken up, and No. 2, Geithner was the president of the Federal Reserve Bank of New York and doesn't' want to admit that it messed up. So Pearlstein argues that the White House has been a defender of Wall Street.

So now, the industry has hired lobbyists to persuade the Congressmen to get rid of the derivatives amendment which forces them to put this business into a separate subsidiary and will required them to have a separate set of capital. Predictions are that the Lincoln amendment will be dropped. The Administration is said to be pushing for that and Senator Chris Dodd doesn't want it, according to Pearlstein in the TV interview. While the house bill has been criticized for having too many loopholes, the senate bill is viewed as more restrictive. All eyes will be on how they reconcile these two bills. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio