The Derivatives Bill Friday's Goldman-SEC News Overshadowed

Last Friday, when business journalists everywhere were drooling over the SEC's announcement of its lawsuit against Goldman Sachs, Senate Agriculture Committee Chair Blanche Lincoln (D-AR) released her aggressive bill (.pdf) to regulate the derivatives market. Leaks advertised the bill as the most serious crackdown to date on Wall Street's profit center for making and trading complex securities. Its actual text includes some very controversial provisions, but the bill isn't quite as aggressive as some early reports indicated. For example, Lincoln provides regulator flexibility in determining how aggressively to implement some of her changes.

After the Senate Banking Committee passed its financial reform bill, Chairman Dodd (D-CT) indicated that its derivatives section was just a placeholder for a new version some of its members intended to produce. Since those senators have yet to deliver an amended version of that section, there's talk that Lincoln's bill could take its place. Here are some of its more important highlights (.pdf):

Real Time Reporting

One of the most significant changes would require almost all derivatives trades to be reported real-time. Currently, many over-the-counter transactions are not reported to the SEC.

Mandatory Clearing

Lincoln wants virtually all derivative trades to go through a clearinghouse. Right now, some trades are cleared, but many are not. A clearinghouse acts as a third-party that nets trades and minimizes counterparty risk. The trades will also have to go through regulated exchanges.

No Bailouts for Derivatives

In an effort to prevent future bailouts, Lincoln wants to make sure derivatives deals that go bad don't fall on the shoulders of taxpayers. As a result, she seeks to prohibit federal funds being used to pay off obligations of failed firms arising from derivatives exposures.

Segregates Derivatives

The new bill also seeks to separate a firm's derivatives activity from its other business. The intention here is to create derivatives dealers who can more easily fail and won't bring down large institutions with them if their trades go bad.

Enforcement Authority

The legislation would also provide regulators with enhanced enforcement authority to prosecute investors who use derivatives to hide information from the market. It also includes increased bounties paid to whistle-blowers.

While these ideas might sound good at first blush, some are very controversial and would radically change the derivatives market Wall Street knows today. More analysis on that tomorrow.