The administration is seeking to increase the transparency of the $600 trillion global derivatives market and has proposed that big investment banks that trade derivatives be subject to requirements for holding capital reserves against risk. In addition, a new network of clearinghouses would be established to provide transparency for trades in credit default swaps and other derivatives.
The House Agriculture and Financial Services committees recently agreed on guidelines for a measure similar to the administration's proposal. But Commodity Futures Trading Commission Chairman Gary Gensler has urged lawmakers to tighten the legislation in several areas, including eliminating exemptions from new requirements for foreign-currency swaps and small firms dealing in derivatives.
Gensler says excluding foreign-currency swaps from the new restrictions could enable dealers to structure other swaps transactions in a way to skirt regulation.
"The law must cover the entire marketplace, without exception," he told the House Agriculture Committee Tuesday.
The value of derivatives hinges on an underlying investment or commodity - such as currency rates, oil futures or interest rates. The derivative is designed to reduce the risk of loss from the underlying asset.
But many derivative contracts ended up spreading risk instead. "The financial crisis has taught us that the derivatives trading activities of a single firm can threaten the entire financial system," Gensler said, referring to American International Group Inc.
AIG's derivative trading group "was not subject to any effective federal regulation," he added. The insurance company later received a government bailout valued at more than $182 billion.
Meanwhile, the Securities and Exchange Commission - the government's primary securities markets watchdog - and the CFTC, which oversees the trading of oil, gas and other commodities as well as financial instruments, have started coordinating their rules to eliminate differences involving similar types of investments such as derivatives.
Credit default swaps, a form of insurance against loan defaults, account for an estimated $60 trillion of the so-called over-the-counter derivatives market. The collapse of the swaps brought the downfall of Wall Street banking house Lehman Brothers Holdings Inc. a year ago and nearly toppled AIG.