By Kevin Drawbaugh and Rachelle Younglai
WASHINGTON (Reuters) - Banks looked increasingly likely to face some limits on swap trading as a proposal to rein in risky business practices gained traction among lawmakers negotiating a landmark Wall Street reform bill
In a rebuke to the banking industry, lawmakers on Monday were warming to a revised proposal from Democratic Senator Blanche Lincoln that would force some banks to spin off lucrative over-the-counter derivatives trading operations.
The proposal to rein in risky business practices by banks, once seen as dead-on-arrival, had new life breathed into it last week after Lincoln, an Arkansas Democrat, won a primary election in which she campaigned against banks.
Lawmakers have been responding to voter anger against banks ahead of the general elections in November.
A document obtained by Reuters on Monday offered fresh details on Lincoln's latest thinking, with provisions aimed at mollifying critics.
The proposal now would limit what kinds of activities would have to be spun off, allowing banks to continue hedging their own risks in-house using swaps, among other changes.
A senior aide said that portions, at least, of Lincoln's proposal will be incorporated in legislation expected to be finalized by the end of the month by a joint U.S. Senate-House of Representatives conference committee.
The panel will meet for the second time on Tuesday to consider new rules for private pools of capital and credit rating agencies.
Representative Barney Frank, the Democrat who is chairing the committee, on Monday called for dropping the Senate's most controversial plan to regulate credit rating agencies.
The Senate bill would create a board to match raters with debt issuers. The provision aims to mitigate conflicts of interests at the largest credit rating agencies -- Standard & Poor's, Moody's Corp and Fitch Ratings -- which are paid by the issuers whose debt they rate. Instead, Frank is proposing a study of credit rating agency reforms.
Frank also wants to ensure that advisers to hedge funds and private equity funds register with the Securities and Exchange Commission. The Senate bill exempts private equity funds from more oversight.
The back and forth is part of final negotiations on the biggest rewrite of U.S. financial rules since the 1930s.
Once approved by the committee and both chambers of Congress, the legislation would be sent to President Barack Obama to sign into law. Enactment would give Obama and fellow Democrats a major domestic policy achievement to add to healthcare reform ahead of general elections in November.
WIDE IMPACT OF LINCOLN PLAN
Lincoln's plan could have far-reaching impact for some of Wall Street's largest and more storied institutions.
The unregulated OTC derivatives market, including swaps, produced about $24 billion in industrywide revenues in 2009, with an estimated 98 percent of that total generated by JPMorgan Chase, Bank of America, Goldman Sachs, Morgan Stanley and Citigroup.
Conferees met with Lincoln staff members over the weekend, as well as staffers for other Democratic senators, aides said.
Amid concerns about profits being cut if the Lincoln plan and other reforms are approved, bank stocks fell on Monday as earlier broad gains on Wall Street were largely reversed.
The bill under consideration presently contains Lincoln's initial proposal to force banks to choose between their lucrative over-the-counter derivatives trading desks and access to government protections, such as emergency lending by the Federal Reserve.
White House economic adviser Paul Volcker, a former Federal Reserve chairman, said on CNBC television on Monday that Lincoln's original proposal was too sweeping. He said it may make sense to separate some swaps activities from banks, but it was difficult to draw clear lines between banks, their holding companies and affiliates.
"The proposed legislation ... has certainly taken account of some of the objections," he said.
According to a Senate aide, banks would need to spin off only swaps dealing activities to an arms-length affiliate under Lincoln's plan, but all swaps players, including exchanges and clearinghouses, would have access to emergency loans from the Fed.
"The whole point behind this, I thought, was so that the derivatives business did not have access to government aid. So if you set them up separately then still give them access, I don't see what you've achieved," said Matthew Magidson, a lawyer at Lowenstein Sandler in New York.
(Additional reporting by Roberta Rampton, Charles Abbott, Caren Bohan, Kim Dixon and Andy Sullivan in Washington, and Steve Eder and Elinor Complay in New York; Editing by Leslie Adler)
