By Sarah N. Lynch and Douwe Miedema
WASHINGTON (Reuters) - Democratic Senator and Wall Street critic Elizabeth Warren is urging federal regulators to "show some backbone" and stick to their proposal for how new derivatives rules will apply to foreign banks who do business with U.S. companies.
"If the Commodity Futures Trading Commission moves in the wrong direction here, it could create loopholes that the big banks will be able to drive a truck through," Warren said in an interview with Reuters on Thursday.
"We need to remember the enormous role that the unregulated derivatives market played in the 2008 financial collapse. I know it has been five years, but our regulators need to have more memory than that and they need to show some backbone here," the freshman lawmaker from Massachusetts said.
Her remarks are significant because a temporary exemption that grants banks more time to comply with the new rules expires on July 12, and the CFTC is under considerable pressure to extend it.
The exemption allows foreign banks to continue doing business as usual until the CFTC makes a final decision on how broadly to apply its U.S. rules.
Banks, foreign regulators and some members of Congress have assailed the commission for crafting a plan they say is too aggressive and far-reaching.
Under the CFTC proposal unveiled last summer, foreign banks would have to register with the agency as "swap dealers" and comply with the same rules as American banks if their annual swaps trading volume with U.S. banks exceeds $8 billion.
European regulators have been particularly harsh, saying the scope of the CFTC's proposed reach for U.S. rules could create duplication.
They have urged the CFTC to carve out foreign branches and certain affiliates of U.S. banks from the rules, and to give foreign regulators greater leeway in policing their own markets.
Derivatives are contracts that derive their value from other assets, and are often used by companies seeking to reduce their exposure to risks like interest-rate fluctuations.
'DIRECT AND SIGNIFICANT'
Bad derivatives bets at American International Group nearly toppled the company and led to a massive government bailout during the 2008 financial crisis.
In response to that, the 2010 Dodd-Frank Wall Street reform law requires swap dealers and major traders to set aside capital and post margin.
It also calls for swaps to be routed through clearinghouses to protect against default and to be traded on regulated platforms.
Although the law focuses primarily on U.S. trading, it contains a provision that calls for American regulators to oversee trading abroad it if has a "direct and significant" effect on U.S. business.
The power struggle between the CFTC and foreign regulators is further complicated because the CFTC also shares authority with the Securities and Exchange Commission to police over-the-counter derivatives trading.
Last month the SEC came out with its own cross-border swaps plan that differs substantially from what the CFTC initially proposed. It would give some regulatory relief to foreign branches of U.S. banks and guaranteed affiliates, and give more deference to foreign regulators.
Frustrated by the different approaches between the two regulators, a bipartisan group of lawmakers in the House of Representatives on Wednesday passed a bill that would force the CFTC and SEC to jointly write rules and exempt trading outside the United States unless the foreign country did not have equivalent rules.
The House bill is at odds with the position of several influential senators. Earlier this year, Senator Carl Levin, a Michigan Democrat, also said he feared the CFTC might water down the rules.
In a letter to regulators, he pointed to a London-based trader at JPMorgan, whose credit derivatives trades cost the bank $6.2 billion in losses, as an example of why U.S. rules should be applied more broadly.
Warren said she opposes the House bill, which also received a veto threat from President Barack Obama earlier in the week.
"I understand the CFTC and the SEC are operating under different statutory authorities here, but I think the SEC's rules fall short," Warren said. "The CFTC's approach is far better."
(Reporting by Sarah N. Lynch and Douwe Miedema; Editing by Karey Van Hall and Xavier Briand)