OTC derivatives bill

On Friday, Rep. Barney Frank (D-MA), the chairman of the Financial Services Committee of the House of Representatives, released a "discussion draft" of legislation to regulate over-the-counter derivatives.

This draft takes a point of view distinct in an important respect from that of the administration. The White House/Treasury proposals have focused on standardizing OTC derivatives so that they could be processed through clearing houses, in the expectation that such clearing would lower the risk of such instruments to the broader financial system.

Look at this from the point of view not of hedge funds or speculators, but of companies who really use derivatives to hedge their operational positions. Airline companies, for example, are in the market for derivative products in regard to oil prices. Why? because sharp increases in oil prices proves very costly to their operations, so they look for a way to make such a sharp increase work for them through the derivative, getting them back in one pocket what that development takes away from them via the other.

Yet airlines might have a tougher time doing this under the Obama proposal than they'd like, because the centralized clearinghouses could require they put up cash or liquid assets as collateral. That would burn a hole in their balance sheets.

The discussion draft says that the requirement for OTC swaps to be cleared centrally would not apply if "one of the counterparties to the swap is not a swap dealer or other major swaps participant." Learn more here.

See the discussion draft itself here.