As FOW went to press, a Senate vote was imminent, having been delayed from before the July 4 holiday, partly because of the death of Democratic senator Robert Byrd.

The Senate could yet cause problems for the Wall Street Reform and Consumer Protection Act, as Democrats now only hold 58 seats – not enough to prevent a Republican filibuster.

In a last minute concession to win over Republicans, Democrats removed from the bill a $19bn levy on banks to pay for the costs of regulatory reform and possibly liquidating a large bank.

Clearing and transparency

Should the bill be approved, it will change the US derivatives market – though not as much as some reformists had hoped.

The proposal makes increasing market transparency a critical objective. Clearing houses and swap repositories will have to collect and publish data about derivatives trading.

At the heart of the bill is the requirement for derivatives that can be centrally cleared to be centrally cleared. Both the Securities and Exchange Commission and the Commodity Futures Trading Commission will decide which contracts will have to be cleared. They will also be given authority to oversee the OTC market.

Volcker-lite

The bill contains weakened versions of the controversial Volcker Rule and Lincoln Amendment.

The Volcker Rule, originally formulated by former Federal Reserve chairman Paul Volcker, is the idea that deposit-taking banks should be forbidden from proprietary trading or investing in hedge funds and private equity.

In the convoluted form in which it appears in Section 619 of the Act, the Rule spreads out over 30 pages with many exceptions and exceptions to exceptions.

Key points are:

· Banks will be forbidden from proprietary trading in securities or derivatives, except US Treasury, state, municipal and federal agency bonds (including those of Ginnie Mae, Fannie Mae and Freddie Mac). The prohibition will also not apply to any trading on behalf of customers, nor to “risk-mitigating hedging activities”, nor to any trading “in connection with underwriting or marketing-making-related activities, designed not to exceed the reasonably expected near term demands of clients, customers, or counterparties.”

· Also allowed are trading by an insurance company for its general account, activities that “promote the safety and soundness of the banking entity” and selling and securitising loans

· Non-bank financial companies supervised by the Federal Reserve Board will bear higher capital requirements for such activities, except for some exceptions

· Banks can invest in their own hedge funds and private equity funds, as long as they reduce their holdings to no more than 3% of the fund’s equity. All such investments should not exceed 3% of the bank’s Tier 1 capital

· Forbidden is anything that causes a “material conflict of interest” between the bank and its clients or counterparties, anything that would expose the bank to “high risk” assets or trading strategies, and anything that would threaten the bank’s safety and soundness or the financial stability of the US

· It will be three to four years before firms have to comply

Diet Lincoln

The original intent of Senator Blanche Lincoln’s Amendment was to make deposit-taking banks move their swaps trading desks into separately capitalised affiliates, to ensure that they were ringfenced and could not absorb government rescue funds.

After last minute changes, a softened version of this provision is contained in Section 716 of the Act. Now all swaps activity used to hedge risks for the bank can stay within the bank. So, it appears, can swaps activity in foreign exchange and interest rate risks, as well as credit default swap activity, as long as it is cleared by a clearing house.

Key points are:

· “Swaps entities” may not be bailed out with federal money

· Swaps entities are dealers or major participants in swaps or security-based swaps that are registered under the Commodity Exchange Act or Securities Exchange Act

· Swaps entities does not include insured depository institutions that are major participants in swaps or security-based swaps. Presumably this means that banks are only swaps entities if they are dealers in swaps, not just major participants. So banks that are major participants in swaps may still be bailed out. Banks can remain eligible for bailout funds if they own affiliates which are swaps entities

· Banks can also remain eligible for bailout funds if they confine their swap or security-based swap activities to these activities: hedging and other similar risk-mitigating activities directly related to their activities; dealing in or participating in swaps “involving rates or reference assets that are permissible for investment by a national bank”; dealing in credit default swaps as long as these are cleared by a clearing house.

· If any FDIC-insured swaps entity, or any systemically important firm, becomes insolvent as a result of swaps activity, its swaps positions can be terminated or transferred, and no taxpayer funds can be used to prevent it going into receivership if the failure results from the swap activity

More work to come

The Act still contains many ambiguities that need to be clarified and will be fleshed out over the coming months.

Legislators have even hinted that this Act is only a first step. Congressman Barney Frank, the Act’s main sponsor in the House of Representatives, is reported to have said that another bill is expected which will correct and clarify the current Act.

“I think the law will be passed,” said Ronald Filler, professor of law and director of the Center on Financial Services Law at New York Law School. “The interesting question is what the impact is of the new regulation on the banking and derivatives business in the US.”

It is likely to take many months of negotiation and lawyering before that becomes clear.