U.S. Treasury Secretary Timothy Geithner said on Wednesday there was a good case to let some firms use derivatives with little scrutiny for business purposes, but that most trading should face stiffer rules.

Renewing a push to tighten regulation of over-the-counter derivatives, Geithner also urged lawmakers to let regulators block companies from customizing derivatives contracts to avoid trading on central clearing houses as a way to evade the view of regulators.

He told the Senate Agriculture Committee that it was imperative regulators get powers to proactively require central clearing of any derivative types whether or not they are currently accepted for clearing.

We ... should require that regulators carefully police any attempts by market participants to use spurious customization to avoid central clearing, Geithner said.

OTC derivatives have been blamed for aggravating the credit crisis that struck in 2007 and drove the U.S. economy into a deep recession from which it is only slowly emerging.

Subjecting these little-understood, scantily regulated contracts to more supervision is a fundamental element of the Obama administration's bid to overhaul financial regulation to prevent future crises.

Geithner noted that lawmakers have been working on provisions that would exempt some non-financial firms that use derivatives to hedge against business risks from having to face the same heightened regulation banks, insurers and others that use these complex contracts for speculation would come under.

I'm not sure we've got that balance right yet. But I think there probably is going to be a good case for some carefully crafted limited exceptions for non-financial end users, he said, expressing concern over the risk of loopholes that could be exploited.

In response to a question, Geithner agreed airlines might be a case in point, since they regularly use derivatives as a hedge against potential spikes in fuel costs.

Both the U.S. House of Representatives and the Senate are working on proposals to put a tighter rein on derivatives trading and Geithner said he was pleased by the convergence that he felt was developing to make markets more transparent.

While the House Financial Services Committee has approved a bill that would allow exceptions for non-financial firms, no regulatory reform measures have yet faced a committee vote in the Senate.


There was support on the Senate panel for Geithner's bid to shine a brighter light on activity in derivatives markets where wheeling and dealing has swelled in recent years to levels that dwarf trading in regulated markets.

We need to remember our over-arching goal -- increasing transparency and accountability in the nation's financial markets, Committee Chairwoman Blanche Lincoln said at the start of the hearing.

Derivatives are financial instruments that derive their value from an underlying asset like a stock, Treasury bond or a commodity such as oil.

Some derivative products are traded on exchanges and centrally cleared while other, customized transactions are made over-the-counter or between individual parties, and are not centrally cleared, providing for far less transparency.

Lack of transparency in OTC derivative markets, combined with insufficient regulatory power to police these markets, left our financial system more vulnerable to fraud and manipulation, Geithner said.

Central clearing interposes a regulated clearinghouse between the original counterparties in a derivatives transaction and so creates an opportunity to make dealing more transparent.

With careful supervision and regulation of the margin and risk management practices of clearinghouses, central clearing of a substantial proportion of OTC derivatives should help to reduce the risks arising from the web of bilateral interconnections among our major financial institutions, Geithner said.

That would reduce the prospect of threats to financial stability stemming from derivatives dealing that is measured in the hundreds of trillions of dollars annually, he added.

(Additional reporting by Rachelle Younglai, Tim Ahmann and Doug Palmer; Editing by Andrea Ricci)