US legislation for OTC derivatives market published

The US Treasury has published draft legislation detailing its plans to fully regulate over-the-counter (OTC) derivatives markets and mandate central clearing for all standardised bilaterally negotiated contracts.

The draft Over-the-Counter Derivatives Markets Act of 2009 lays out in detail how a centrally cleared OTC market would work, though it stops short of providing the comprehensive definition of a "standardised" contract.

The legislation specifies that a swap accepted for clearing by any registered derivatives clearing organisation shall be presumed to be standardised by all market participants. An exhaustive definition will be published within 180 days of the enactment of law, when the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) jointly define the parameters.

"In adopting such rules, the Commission and the SEC shall jointly define the term 'standardised' as broadly as possible, after taking into account: the extent to which any of the terms of the swap, including price, are disseminated to third parties or are referenced in other agreements; the volume of transactions in the swap; the extent to which the terms of the swap are similar to the terms of other contracts that are centrally cleared and whether any differences in the terms of the transactions that are centrally cleared are of economic significance," the legislation reads.

The act is unequivocal in stating that "it shall be unlawful to enter into a swap that is standardised unless the swap is cleared by a derivatives clearing organization registered under this Act; and the rules of the derivatives clearing organization prescribe that all swaps with the same terms and conditions are fungible and may be offset with each other".

The 115-page draft largely fleshes out pledges made in the March white paper that announced Treasury secretary Timothy Geithner's plans to overhaul the derivatives markets. Non-standardised OTC contracts ineligible for central clearing will have to be registered with a trade repository such as the Depository Trust & Clearing Corporation's Trade Information Warehouse.

After the act is signed into law, counterparties to a customised swap agreed before the legislation was passed will have to report the transaction to a trade repository within 180 days, while non-standardised trades entered into after the law is implemented must be reported within 90 days.

Deputy Treasury secretary Neal Wolin rejected suggestions the legislation was designed to stamp out the non-standardised market altogether and move all derivative contracts on to clearing houses.

"The goal is not to shut down the customised OTC market but to ensure that the customised market is used appropriately and that any risks that build up in the system are dealt with through capital and margining provisions," Wolin said. "The proposal creates incentives to move toward standardisation because capital and margin requirements would be higher in the customised space so more product will be moved into the standardised space under that broad definition of standardisation."

Wolin confirmed that copies of the draft legislation have been sent to both Senate and House agriculture committees as well as the Senate Banking Committee and House Committee on Financial Services.

However, industry representatives cautioned against restricting the versatility of OTC markets.

"We are examining the details of the draft legislation being especially mindful of the need to preserve the availability and flexibility of privately negotiated derivatives for American companies. Privately negotiated derivatives are important both in order for American companies to manage risk as well as to compete on a global basis. We look forward to working with Congress and with regulators to address these important matters," said Robert Pickel, chief executive of the International Swaps and Derivatives Association.

See also: NYSE Liffe shuts down CDS clearing service
Momentum gathers for central trade repository
EC calls for greater standardisation of over-the-counter derivatives
House committee chairmen produce roadmap to OTC reform
Geithner outlines regulations for over-the-counter market