Administration proposes rules for standardizing derivatives

WASHINGTON – The Obama administration on Tuesday sent Congress its proposal to regulate a complex part of the financial world that played a key role in the near-meltdown of the global financial system last year.

The comprehensive plan to regulate so-called derivatives was the final element in the largest proposed overhaul of U.S. financial regulation in generations. Tuesday’s plan would subject a largely unregulated financial market whose size is in the trillions of dollars to federal scrutiny.

Derivatives have grown explosively in recent years, developing faster than regulators could keep pace with, especially the market for swaps. These are private deals between two parties on anything from a change in the value of the dollar versus other currencies to a bet that a company will default on its corporate bonds or suffer a downgrade of its credit rating, called a credit-default swap.

Credit-default swaps were instrumental in the near-collapse of the global financial order last September. The Federal Reserve and the Treasury Department saved insurance giant American International Group from collapse, concerned that the lack of transparency in swaps markets would trigger runs on other financial institutions.

Neither markets nor regulators were certain who owed what to whom in the swaps market. There was no central place to settle the bets or to resolve disputes.

That’s where Tuesday’s proposed legislation comes in. Under the Treasury’s plan, most derivatives would become standardized financial products and be traded on a regulated exchange, much as stocks and commodities are. Settling these private bets would take place in a clearinghouse regulated by either the Commodity Futures Trading Commission or the Securities and Exchange Commission.

One especially popular swap product involves energy prices, with two parties betting on the price movements of oil, airline fuel, natural gas and other products.