Legislation aimed at tightening oversight of the $592 trillion derivatives market would give the Commodity Futures Trading Commission new authority to police over-the-counter commodity swaps as well as derivatives traded on foreign exchanges. The commission would get the power sought by Chairman Gary Gensler to regulate bilateral swaps in commodities such as wheat and natural gas, and may impose position limits on speculation that takes place outside of regulated exchanges, according to a 187-page draft measure released Oct. 2 by House Financial Services Committee Chairman Barney Frank. The legislation advances the commission’s efforts to “effect comprehensive oversight of the OTC markets to ensure transparency and accountability to these currently opaque markets,” Commissioner Bart Chilton said in an e-mail. The commission needs this authority to make sure U.S. consumers are paying “fair prices” for commodities, he said. Opaque financial products, including some derivatives, have contributed to almost $1.6 trillion in writedowns and losses at the world’s biggest banks, brokers and insurers since the start of 2007, according to data compiled by Bloomberg. Among fallen companies are Lehman Brothers Holdings Inc., the investment bank that filed for bankruptcy, and insurer American International Group Inc., which has been surviving on government loans. The Securities and Exchange Commission and the CFTC would get the power to “prohibit transactions in any swap” that regulators determine “would be detrimental to the stability of a financial market or of participants in a financial market,” according to the proposal from Frank, a Massachusetts Democrat. Commission Hearings The CFTC held hearings in July and August on how best to limit speculation in energy markets amid concerns that speculators drove oil prices to a record high of $147.27 a barrel on July 11, 2008. Gensler has said that he believes speculation contributed to high commodity prices last year. Frank’s legislation would extend the CFTC’s authority to any foreign board of trade offering direct access to U.S. investors on any linked “agreement, contract or transaction” that settles against any price of one or more contracts listed for trading on a “registered entity.” Foreign boards of trade offering a linked contract would be required to set position limits, release trading data, and have rules in place to prevent market manipulation and excessive speculation. The legislation would affect swaps investors such as the $4 billion U.S. Natural Gas Fund, the largest exchange-traded fund in the fuel. The fund has been prevented from expanding its gas holdings on the New York Mercantile Exchange or the Intercontinental Exchange Inc. by limits intended to curb energy speculation. That meant it couldn’t offer new shares, which it backs with natural gas investments, the fund said in an Aug. 12 SEC filing. Gas Swaps So the fund began buying bilateral swaps instead. On Oct. 2, the fund issued its first new shares since July. Instead of exchanging the 7 million new shares for cash, the fund traded the shares for gas swaps. The legislation offered by Frank would require the most common and actively traded over-the-counter derivatives contracts to be bought and sold on exchanges or processed through a regulated trading platform. “We can’t effectively protect American consumers, and make sure they are paying fair prices for food, gas and other commodities, unless we have a clear window into the trading that affects commodity pricing,” Chilton said in a statement that described Frank’s proposal as helping “to move this discussion down the road.” Treasury Department The measure also would give the Treasury Department the final say if the SEC and CFTC couldn’t agree on joint regulations, including setting position limits or the treatment of products that are economically similar, such as stock options and stock futures. A three-page proposal released by Frank in July would have given that power to a new Financial Services Oversight Council. Derivatives are contracts used to hedge against changes in stocks, bonds, currencies, commodities, interest rates and weather. Credit-default swaps are derivatives that were created primarily to protect lenders and bondholders from company defaults. Some lawmakers and regulators have said they may have been used to spread false rumors about financial companies to drive down stock prices. Frank’s proposals stopped short of barring “naked” credit-default swaps, where the buyer doesn’t own the underlying asset being hedged. The lawmaker had said he was considering such a ban. ‘Pro-Growth’ Democrats The draft by Frank won praise from potential opponents in the New Democrat Coalition. The group, which describes itself as moderate and “pro-growth,” had offered competing legislation that would have given Treasury veto power over regulations enacted by the SEC and the CFTC. “Chairman Frank’s draft provides a solid start to discussions about reforming the derivatives market,” said Representative Michael McMahon, a New York Democrat who was lead sponsor of the competing measure. To contact the reporters on this story: Asjylyn Loder in New York aloder@bloomberg.net; Dawn Kopecki in Washington at dkopecki@bloomberg.com.

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