Two key U.S. lawmakers clashed on Tuesday over cracking down on swaps trading as a clearer shape emerged for a House-Senate panel that must finalize a major rewrite of financial regulation.

In a sign a flashpoint on the panel will be how to police a $615-trillion swaps market dominated by Wall Street giants, Representative Barney Frank challenged a proposal from Senator Blanche Lincoln to curb swap trading by banks.

Frank, who will chair the House-Senate conference committee, said he disagreed with Lincoln's plan to force banks to spin off units that trade in swaps, a kind of derivative contract involved in the 2007-2009 capital market crisis.

In remarks that could dim the outlook for Lincoln's controversial proposal, Frank said there was no need to force banks out of the over-the-counter derivatives business, which includes credit default swaps and other types of contracts.

Firing back at Frank's remarks given at a conference early on Tuesday, Lincoln said in a statement provided to Reuters:

I agree with Chairman Frank that we must preserve a bank's ability to use swaps to manage risks ...

However, using swaps to manage risk and using depositors' money for casino-style swap dealing are two very different things. The Senate bill moves this risky activity out of the bank and into fully regulated entities, protecting depositors and American taxpayers.

The exchange between the two lawmakers presaged the kind of debate likely next month as the conference committee gets to work on ironing out differences between a Senate bill approved last week and a bill approved by the House in December.

One of the starkest difference is the Lincoln provision. It is in the Senate bill, but not in the measure from the House of Representatives, which was drafted largely by Frank and approved with no Republican backing.

12 SENATE CONFEREES NAMED

The Senate appointed a mix of moderates and hard-hitting reformers to the conference. Frank is recommending that eight Democratic House members be named to the conference, including some of the financial services industry's harshest critics, according to a memo obtained by Reuters late on Tuesday.

Together, the House and Senate lawmakers must merge the two bills, then win approval for the final product in both chambers and send it to President Barack Obama to sign into law.

Analysts expect enactment could happen before July 4. That would cap a year-long regulatory reform drive, one of the White House's top domestic policy priorities going into November's mid-term congressional elections. Political debate has been fueled by widespread voter anger at Wall Street after the severe financial crisis and economic recession.

Senate Banking Committee Chairman Christopher Dodd will be a conference member. So will fellow Democrats Charles Schumer, Jack Reed, Tim Johnson, Tom Harkin, Patrick Leahy and Lincoln.

They will be joined by Republicans who have steadfastly opposed most, if not all the Democrats' proposals for tightening bank and market oversight. They include Richard Shelby, Bob Corker, Mike Crapo, Judd Gregg and Saxby Chambliss.

Some senators who have championed particularly tough financial reforms, such as Richard Durbin, Jeff Merkley and Carl Levin, were excluded from the conference -- a development that analysts said could point to more centrist legislation.

Frank is recommending the appointment of himself to the conference, as well as Democrats Paul Kanjorski, Luis Gutierrez, Maxine Waters, Melvin Watt, Gregory Meeks, Dennis Moore and Carolyn Maloney, said the memo to Democratic members of the House Financial Services Committee that Frank chairs.

The House Republicans' conferees were still not known.

Reed, a Senate appointee, said on Tuesday that derivatives and credit rating agencies would be among his top issues in the conference, and he hoped the final product would retain a Durbin provision in the Senate bill limiting debit card fees.

He also said he preferred an approach to curbing risky trading by banks that Merkley and Levin had unsuccessfully tried to get into the Senate bill over Lincoln's provision. Merkley-Levin is more targeted, more effective, he told reporters in the Capitol.

VOLCKER RULE LIKELY-FRANK

Frank said he believed another proposed restriction -- the so-called Volcker rule that would prohibit banks' proprietary trading -- was sufficient to limit their risky activities.

A version of the Volcker rule is included in the Senate bill. It would leave implementation to regulators, opening the way to watering down the rule later.

The House bill would let regulators bar proprietary trading -- in which banks buy and sell investments on their own books unrelated to customer needs -- in cases where financial stability is threatened.

But it does not explicitly endorse the rule, which Frank said he believed will be adopted in the final version.

(Additional reporting by Rachelle Younglai, Charles Abbott, Andy Sullivan and Thomas Ferraro in Washington, Steve Eder in New York and Huw Jones in London; Editing by Andrew Hay)

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