WASHINGTON - Legislation adopted five years ago was supposed to settle once and for all the enforceability of banks' swaps contracts.
But new legislation already voted out by a Senate committee has reopened the debate.
The focus is a provision of a bill to reauthorize the Commodity Exchange Act. The bill cleared the Senate Agriculture Committee in July.
Senate Banking Committee leaders and industry representatives say the provision, which would grant the Commodity Futures Trading Commission more control over a swath of financial products, is a major problem.
"We are concerned that the legal certainty for certain legitimate transactions … could be undermined," wrote Senate Banking Chairman Richard Shelby and Sen. Paul Sarbanes, the panel's lead Democrat, in a letter to Agriculture Committee leaders.
If they are correct - and among those who agree is Federal Reserve Board Chairman Alan Greenspan - swaps contracts with trillions of dollars of notional value could be affected.
Most observers thought this issue was settled in 2000, when Congress made sweeping changes to the 31-year-old commodity trading law. It explicitly exempted all banking products - including swaps contracts entered into by financial institutions and new bank products - from regulation by the commission.
The financial services industry had been clamoring for years for the clarification to give the sophisticated risk-management instruments legal certainty. Because swaps, like CFTC-regulated futures, are agreements to sell or exchange something at a future date, the commission had suggested that swaps come under its jurisdiction.
Futures are required to be traded on exchanges. By putting swaps under CFTC jurisdiction, they too would have to be traded on exchanges. That would be impractical for bank swap contracts - whose notional value came to $61 trillion on June 30 - since they are individually designed to fit the unique needs of a particular transaction and cannot be traded on exchanges, bankers say.
As a result, by going under CFTC regulation, bank swaps contracts would become illegal and unenforceable, because they are not traded on exchanges.
Senate Banking and industry officials are concerned that a provision in the Senate Agriculture bill could undermine the legal status of some swaps. The provision - intended to address fraud problems raised in a recent court decision that calls into question the commission's authority over certain foreign-exchange products to retail investors - would give the CFTC jurisdiction over foreign exchange transactions and anti-fraud authority.
"We are concerned that the proposed language may be overbroad and includes financial products that were specifically excluded from the regulatory regime created by" the legal clarifications made in 2000, Sens. Shelby and Sarbanes wrote.
Fed Chairman Greenspan has also weighed in. "The issues are complex and the potential for legislation to have unintended consequences, including uncertainly about the enforceability of legitimate transactions that do not involve fraud, is considerable," he wrote in a July letter to the Senate.
The members of the President's Working Group on Financial Markets - composed of the Fed, the CFTC, the Treasury Department, and the Securities and Exchange Commission - are scheduled to testify Thursday at a Senate Banking hearing on this and other policy decisions Congress must make as part of the CFTC reauthorization. Every five years the authorization is considered by the congressional committees with jurisdiction over financial services and agriculture.
The House Agriculture Committee unveiled a bill in July that is similar to the one Senate Agriculture approved, but the House panel has yet to act on its measure.
CFTC Commissioner Sharon Brown-Hruska told Senate Agriculture in March that the regulatory agency "continues to face challenges to its jurisdiction based on how retail forex transactions are characterized."
"Congress may wish to review whether the CFTC has clear and adequate authority to police retail fraud, particularly in the foreign exchange area," she said.
Still, she said, the commission's track record in protecting against fraud in the foreign exchange area is "favorable," including imposing over $240 million in penalties and restitution.
A spokesman for Senate Agriculture Chairman Saxby Chambliss said the Georgia Republican does not plan to bring his bill to the Senate floor until after he finishes negotiations with Senate Banking, the Working Group on Financial Markets, industry, and interest groups.
"The chairman has said this is something he fully expects to be amended and worked through further," a spokesman for Sen. Chambliss said. He noted that Senate Agriculture began holding hearings on the issue in March.
"In all aspects of the CFTC reauthorization, the chairman and the committee senators want to make sure we correctly addressed all the issues that were raised" since 2000, "whether they are legislative, legal, or in the markets themselves," he said. "Certainly chief among those discussed" are the provisions involving the CFTC's authority over retail foreign-exchange products.
Industry officials hope Congress will not make any changes to the commodities law in the reauthorization process.
"There is broad consensus the changes brought in 2000 were a significant step forward and there is not a need for any substantial restructuring," said Robert Pickel, the executive director and chief executive of the International Swaps Derivatives Association, who is to testify at the Senate Banking hearing on Thursday.
He said that the CFTC and other authorities - including the Federal Trade Commission and state attorneys general - could adequately police fraud involving foreign exchange.
