The House Financial Services Committee is to begin work on Wednesday on a top priority for the U.S. Congress -- legislation to mend regulatory holes exposed by last fall's financial crisis.

The committee will focus this week on bringing the $450 trillion market in over-the-counter derivatives under federal regulation and creation of an agency to protect consumers from risky financial products.

A reform package could go to a floor vote next month. The committee has scheduled sessions next week to work on provisions on hedge funds, insurers and brokerages.

Financial regulatory reform was one of the top three issues when Congress convened this year. Momentum has slowed as markets stabilized.

Chairman Barney Frank said at a hearing last week that more OTC derivatives should go through clearinghouses but that won't always be possible. Frank also supported an exemption from clearing for nonfinancial firms that use derivatives as part of acquiring supplies for their operations.

The Obama administration says all standardized OTC derivatives should go through clearing and all cleared swaps should be traded on regulated exchanges. It would put higher capital and margin requirements on customized contracts.

Frank indicated he would tighten language in a preliminary draft to prevent large swaps users from evading regulation by declaring they use derivatives as a risk management tool.

A draft circulated by Frank would give the new consumer agency broad powers to examine all financial firms, to set compensation practices rules for their executives, to create a central database of consumer complaints.

Financial firms strongly opposed the administration proposal that banks offer plain vanilla versions of their products. The draft would not require that step.

An umbrella group of consumer, community and civil rights groups, Americans for Financial Reform, said there was broad support for the proposed Consumer Financial Protection Agency and to regulate financial derivatives. The group found strong support for both ideas in polling of likely votes in 77 swing House districts.

(Reporting by Charles Abbott; Editing by Diane Craft)

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