Oct. 15 (Bloomberg) -- The Treasury Department backed legislation to overhaul regulation of the $592 trillion over- the-counter derivatives market after a House panel changed provisions the Obama administration said left loopholes.

“The House has taken major steps toward enactment of this bill and is well on the path toward comprehensive financial reform,” Assistant Treasury Secretary Michael Barr said on a conference call with reporters after the House Financial Services Committee amended the measure yesterday.

The committee, headed by Representative Barney Frank, a Massachusetts Democrat, is set to complete action today on the legislation, which would require many derivatives transactions to go through central clearinghouses. The administration wants to subject broker dealers such as JPMorgan Chase & Co. and derivatives users such as American International Group to new margin, collateral and disclosure requirements.

Opaque financial products, including 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. Toppled companies included Lehman Brothers Holdings Inc., the investment bank that filed for bankruptcy, and insurer AIG, which is surviving on government loans.

Administration officials had criticized Frank’s original proposal at a hearing of the panel Oct. 7. That version “could unintentionally preserve existing regulatory gaps,” Henry T.C Hu, director of the Securities and Exchange Commission’s division of risk, strategy and financial innovation, said in testimony.

‘Unintended Consequence’

Gary Gensler, chairman of the Commodity Futures Trading Commission, called the loophole an “unintended consequence” that could exclude from oversight all hedge funds as well as large derivatives users such as mortgage-finance companies Fannie Mae and Freddie Mac.

The House panel responded by passing an amendment yesterday redefining “major swap participants.” Derivatives users large enough to “expose counterparties to significant credit losses,” such as Fannie Mae and Freddie Mac, would meet Frank’s revised definition and wouldn’t be eligible for an exemption.

The latest plan still excludes from new rules most “end- users,” corporations that use derivatives to mitigate their operational risks, such as a rise in oil prices or fluctuations in currency rates.

Barr said the exceptions for end-users in Frank’s draft were “reasonable.”

Republicans on Frank’s panel said yesterday the measure would lead to too much government interference in markets.

“I continue to be fearful that at every single step we’re making the use of derivatives more costly, more cumbersome,” said Representative Jeb Hensarling, a Texas Republican.

Trading on Exchanges

Frank plans to offer today an amendment that would mandate trading on exchanges or swap execution facilities for standard contracts between dealers and their biggest customers. Barr called that provision “essential.”

“We continue to think that as long as the chairman’s amendment is enacted and all dealers and major swaps participants are covered that that is absolutely essential to preserving a strong marketplace, preserving transparency, getting the incentives right in the system,” Barr said. “We don’t want to allow any firm like an AIG to be able to engage in derivatives transactions without requiring those transactions to be reported and to be traded on an exchange or an alternative execution facility.”

Frank said yesterday that transactions with corporations that use derivatives “purely for the purpose of managing risk to their production” wouldn’t have to go on an exchange or trading platform. Companies would still have to report prices and trading.

‘No Hidden Trades’

“There will be no more hidden trades where we don’t know the price,” said Frank.

The House Agriculture Committee has its own version of the derivatives legislation. House Speaker Nancy Pelosi, a California Democrat, would oversee efforts by the panels to forge a final bill.

“We believe the two House committees will pass their bills later this month and Pelosi will then likely combine the two into a hybrid to pass on the House floor before Thanksgiving with Senate action not likely until 2010,” Teddy Downey, Chris Krueger, William Hederman, and Jaret Seiberg wrote in a note issued yesterday by Concept Capital’s Washington Research Group.

Derivatives are contracts used to hedge against changes in stocks, bonds, currencies, commodities, interest rates and weather. Credit-default swaps, one type of privately traded derivative, were used to replicate pools of mortgages that banks created to sell to investors, in what was known as a synthetic collateralized debt obligation.

To contact the reporters on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.com; Shannon D. Harrington in New York at sharrington6@bloomberg.net

Last Updated: October 15, 2009 00:00 EDT