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Derivatives Reform Overview
Legislative bodies in the U.S. and Europe are moving to increase regulation of the over-the-counter (OTC) derivatives market.  In the US, President Barack Obama has signed into law the Restoring American Financial Stability Act of 2010. Regulatory bodies will now begin drafting rules based on the framework in the bill.  In Europe, The Committee of European Securities Regulators (CESR) has issued two consultation papers designed to define certain terms in the new OTC derivatives landscape and asking for comments. The deadline for comment on the two reports, titled “Standardization and Exchange Trading of OTC Derivatives” and “Transaction Reporting on OTC Derivatives and Extension of the Scope of Transaction Reporting Obligations”, is August 16.

 

• Has been signed into law by President Obama on July 21, 2010

• Combines the bills passed by the House of Representatives and the Senate.

• Contains a version of the Lincoln Amendment that requires banks to spin off some of their OTC derivatives operations.

• Would require most derivatives to be traded on swap execution facilities (SEFs) or exchanges and be cleared through clearinghouses.

• Would mandate banks getting federal aid to spin off their OTC derivatives businesses into affiliates.

 

Past Bills

The below bills were proposed earlier in the legislation process and have served as the framework and starting points for the Conference Report.

The Wall Street Transparency and Accountability Act of 2010

•  Originally proposed by Senator Blanche Lincoln (D-Ark.),  Chairman of the U.S. Senate Committee on Agriculture, Nutrition and Forestry, in April.

• The Senate Agriculture Committee voted 13 to 8 to approve the bill in its original form.

• The bill is viewed as one of the toughest pieces of financial reform legislation.

The Restoring American Financial Stability Act

• Originally proposed by Senator Chris Dodd (D-Conn.) in November as the Senate companion bill to the Wall Street Reform Act.
  
  
• After bipartisan negotiations with the members of the Senate Banking Committee stalled, Dodd re-introduced a watered-down version of his original bill.
  
  
• Would create a Consumer Financial Protection Bureau within the Federal Reserve.
  
  
• While the majority of its derivatives regulations are equivalent to the Wall Street Reform Act, Dodd's bill allows regulators to restrict banks from proprietary trading and investing in or owning hedge funds.

The Wall Street Reform and Consumer Protection Act of 2009

• Proposed by Representative Barney Frank (D-Mass), the current chairman of the House Financial Services committee.

• This legislation would regulate and standardize the OTC derivatives market, and establishing a Consumer Financial Protection Agency.

 

The OTC Derivatives Market Act of 2009

• Also sponsored by Representative Frank.

• Would require OTC derivatives contracts to be traded through government regulated exchanges or alternative swap-execution facilities.

• All contracts would go through a regulated central counterparty and be cleared by a federally approved clearing house.
• All dealers, brokers, and organizations that trade in OTC derivatives would be subject to direct government supervision.

In Europe, the discussion has proceeded as follows:

• The European Union plans to mandate central counterparty clearing of standardized derivatives and will move to increase the transparency of transaction reporting.
• The European Commission has said it plans to create regulations that are globally consistent with other markets before the end of 2010.
  
  

 

Although many organizations, including political bodies as well as financial institutions, are involved in shaping the reforms to come, the primary players include the following:

 

The Commodity Futures Trading Commission (CFTC)

• Responsible for regulating the commodity futures and options markets in the U.S.  This includes ensuring transparency in the markets and overseeing trade execution and clearing facilities.

The House Committee on Financial Services

• Oversees the entire financial services industry, including securities.
  
• Oversees the Fed and the treasury.

Federal Reserve

 

 

The European Commission

In the U.S. anyone can draft a Bill, however only members of Congress can introduce legislation. The legislative process begins when a Bill or resolution is numbered, referred to the appropriate committee and printed by the Government Printing Office. The Bill is then placed on the committee’s calendar, and the committee reviews the Bill and determines whether they think it can pass.

 

After the hearings, the subcommittee can make changes and amendments to the Bill as necessary. It then refers it back to the committee for further hearings and discussion, and the committee then votes to recommend, or ‘report,’ the Bill to the appropriate chamber as a whole. If the committee or subcommittee ignores the Bill at any point during this process, the Bill dies.

 

Once the Bill is reported, the Bill is placed on the calendar of either the House or Senate – wherever it originated. The Bill is then debated on the chamber floor. After the debate ends and any amendments have been approved, the Bill is voted on – it either passes or is defeated. If the Bill passes, it is referred to the other chamber where it follows the same route through committee and debate. This chamber can approve the Bill as received, reject it, ignore it, or change it.

 

If the other chamber makes only minor changes, the legislation returns to the first chamber for concurrence. However, when the actions of the other chamber significantly alter the Bill, a ‘conference committee’ is formed to reconcile the differences between the two versions. If the they cannot reach an agreement, the legislation dies. If they do, a conference report is prepared describing the committee members’ recommendations for changes. Both chambers of Congress must then approve the conference report.

 

After a Bill has been approved by both the House and Senate in identical form, it is sent to the President. It becomes law if the President either signs the legislation or, while Congress is in session, takes no action for ten days. If the President opposes the Bill, he can veto it, and this can only be overridden with a two-thirds majority vote in both houses.

 

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The European Commission, which functions as the executive branch of the EU, is the only EU body that can propose new legislation.

When the Commission decides to put forward a proposal, the College of Commissioners adopts it, publishes it in the Official Journal of the European Union, and forwards it to the European Parliament and the Council of the European Union.

The Parliament debates and amends the proposal in a process known as the Parliament First Reading. The proposal then returns to the Commission, which incorporates the changes into an amended proposal and forwards it to the European Council for the ‘Council First Reading.’ The Council, which is composed of twenty-seven national ministers (one for each member state), can either approve and adopt the act, which is then signed into law by the presidents of the Parliament and the Council, or it can decide it does not share the Parliament’s view, in which case it states its differing opinion on how the act should read, known as its ‘common position.’

The common position is forwarded to the Parliament along with the Council’s reasons, and the Parliament has three months to act. This is called the ‘Parliament Second Reading.’ If the Council approves the amended common position, the legislation is adopted. If the Council does not approve the amended common position, a Conciliation Committee, made up of equal members of Council and Parliament, works to produce a joint text. If the Committee cannot agree on a text, the act is not adopted. If it does produce a joint text, and both Parliament and Council then vote to approve it, the act is adopted and signed into law.

 

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In the UK, ministers and their civil servants are responsible for the content of Bills which is drafted by the Parliamentary Counsel. Before a Bill is drafted, the government often organises a period of formal consultation. A ‘Green Paper’ or a ‘White Paper’ is published and the general public and interested organisations can submit their comments and suggestions.

Once a Bill has been drafted, it is presented to Parliament for first reading. This is simply a formal introduction, without discussion, after which the Bill is printed. Bills can be introduced in either the House of Commons or the House of Lords. All Bills concerned with finance are introduced in the House of Commons.

The second reading debate is a general and wide-ranging discussion of the principles and scope of the Bill, usually lasting for one day.

Following the second reading is the committee stage, a detailed clause-by-clause examination of the content of the Bill. The committee must discuss and approve every clause of the Bill, but does not debate its overall scope and purpose. Following this, the Bill enters the ‘Report stage’ in which all MPs can take part in the discussion. Once approved, the Bill returns to the House of Commons for the third reading.

The third reading is a final debate on the overall content of the amended Bill. It is often very short and is then passed on to the House of Lords. If a Bill passes through the House of Lords unchanged, it is immediately submitted for Royal Assent. However if any amendments have been made, the Bill returns to the Commons which then debates each Lords amendment.

Once the Bill has cleared the Lords, it is sent to Buckingham Palace for Royal Assent. When the Queen has given this, the Bill becomes an Act of Parliament and can be implemented.

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