The U.S. House of Representatives team negotiating derivatives reforms is attempting to tighten a debated loophole that would allow some companies to avoid new rules for the $615 trillion over-the-counter market, according to a document obtained Wednesday.

House negotiators offered a new approach to the so-called “end-user exemption” provided to manufacturers and other non-financial companies who want to avoid the extra costs associated with clearing and trading swaps — one of 110 changes proposed to the derivatives section of the bill as a Thursday deadline looms.
The House document proposed to exempt non-financial companies “using swaps to hedge or mitigate commercial risk” from clearing the trades, as long as they explain to regulators how they are meeting financial obligations.

One analyst called the proposed language “confusing.”

“Our initial take is that the language is tougher than the Senate language, but it is difficult to know for sure,” said Jared Seiberg at investment firm Concept Capital.

“We believe conference staff will need to spend more time on this section,” Seiberg said in a note to clients.

The document, which represents the House’s latest thinking on the issues, signaled more talks on the most controversial aspects of the derivatives section still remain.

The recommendations did not address the proposal by Democratic Senator Blanche Lincoln that would force large banks to spin off their swap dealing desks into separately capitalized affiliates of their respective holding companies.

Senate negotiators must agree with the House requests in order for the language to be included in the final regulation bill, which they want to finalize this week allowing President Barack Obama can sign it into law by early July.

Bringing the highly complex $615 trillion over-the-counter derivatives market under the purview of federal regulators has been one of the thorniest issues for lawmakers to grapple with in their sweeping reforms of financial regulations.

As negotiations reached the critical stage, Senate Democrats proposed Federal Reserve governors and the Treasury Secretary would need to agree before a clearinghouse could access the Fed’s emergency funds, according to another document obtained by Reuters.

A WIN FOR CME GROUP-ANALYST

In its proposal on derivatives, the House was tougher than the Senate’s base negotiating text in some areas but offered concessions to the financial industry in others.

The House proposed to revive part of its original version of the bill to restrict major swaps players and banks and financial companies from owning more than 20 percent of clearinghouses, exchanges, or swap execution facilities.

It also recommended clearing houses not be forced to accept credit risk from other clearinghouses — a measure Seiberg interpreted as a “win” for the CME Group, the world’s biggest operator of futures exchanges.

“This limit will tend to concentrate business at the biggest exchanges/clearing houses. That is why this is seen as a win for CME,” Seiberg said.

Swaps required to be cleared would also need to be traded on an exchange or electronic platform, the House proposed. Mandatory trading is a key difference between reforms proposed in the United States and European Union, and could lead to regulatory arbitrage, said Joel Telpner, partner with law firm Jones Day in New York.

“I would expect to the extent players can, they’re going to try to do their transactions to clear through EU-regulated trading houses,” Telpner said.

The House proposed to strike a measure that would require non-bank swap dealers and players face capital and margin levels as strict or stricter than those set for banks.

Instead, capital and margin requirements for non-bank dealers and big players should be set at “appropriate” levels, the House recommended.

Financial arms of manufacturers would get a two-year exemption from clearing, capital and margin requirements, giving some breathing room to companies like Caterpillar, Deere and Co, Ford and Boeing.

The House offer also proposed exempting firms engaged in a “de minimis” amount of swap dealing with or on behalf of customers from new rules for swaps dealers, and said traders could use non-cash collateral to meet margin requirements.

The House removed language that would allow the Treasury to exempt foreign exchange swaps and forwards from regulation.

Regulators are supposed to finalize rules within 180 days but the new proposal said this could take longer.

It also recommended a significantly longer timeframe for regulators to implement provisions in the bill — at least a year after the time of passage, or two months after regulators finalize rules.