A U.S. plan to extend the reach of its derivatives rules across international borders “won’t work” without alteration, a top European regulator said in Washington today.
U.S., Asian and European regulators are gathered in an effort to resolve differences over the international reach of the U.S. swaps rules drafted by the Commodity Futures Trading Commission for Goldman Sachs Group Inc., Deutsche Bank AG and other trading firms. Absent agreement, they risk undermining international efforts to reduce risks in the $648 trillion global swaps market, the overseas regulators told the CFTC.
Patrick Pearson, head of the financial market infrastructure unit at the European Commission, at the meeting warned of risks in the CFTC’s guidance for complying with its rules. “The proposed approaches across the globe simply won’t work. They won’t mesh. They won’t interact. They will cause conflicts,” Pearson said at the meeting. “Washington, we have a problem,” he said.
The CFTC, the main U.S. regulator for interest-rate and credit swaps, is weighing final guidance on the cross-border reach of trading, capital, collateral and other rules. The meeting in Washington was held with the U.S. Securities and Exchange Commission, which shares oversight of credit derivatives and may propose its own cross-border rules in the next few months.
Emil Paulis, the European Commission’s director of financial markets, said at the meeting that regulators should focus on closing loopholes in countries with weak rules rather than than on extending tougher rules across borders. “It is impossible even for the most important jurisdictions to think they can control this market even by having a very far extraterritorial application of the rules,” said.
CFTC Chairman Gary Gensler said the meeting comes at an important time with the commission’s five commissioners seeking to complete documents on the reach of the rules before regulations take effect early next year. The rules and their timing have raised concerns internally at the CFTC.
“I think it would be premature for the CFTC to finalize any of our rules until we see the SEC’s proposal and we see proposals from the rest of the world,” Jill E. Sommers, a Republican commissioner and chairwoman of the advisory committee, said in a telephone interview before the meeting. “We need to make sure that we are in line with them before we finalize anything.”
CFTC Commissioner Bart Chilton has said that a delay could be beneficial to improve coordination. “I am suggesting that we pause, take a breath, and think globally about implementation and compliance dates that are more reasonable — perhaps June 1, 2013,” Chilton, one of three Democrats on the commission, said in an Oct. 2 speech in Rome.
The G-20 nations set an end-of-the-year goal to complete swaps regulations designed to reduce risk and increase transparency in a market faulted for helping to fuel the 2008 credit crisis. Lack of clarity and international wrangling over the rules threaten to delay the deadline, according to the Financial Stability Board, an international regulatory group that has been monitoring new swaps rules.
“Progress to date in cross-border discussions has been slow,” according to an Oct. 31 report from the board. “This risks delaying the full and timely implementation of the G-20 objectives.”
Today’s meeting followed a private gathering this week of overseas regulators with CFTC and SEC staff.
The G-20 regulatory goals were set in 2009. In the U.S., rules to meet those goals are spelled out in the Dodd-Frank Act of 2010. Some Dodd-Frank rules are in place; others have been delayed until Dec. 31.
The CFTC has been facing criticism from overseas regulators since it proposed guidance in June about the international scope of its Dodd-Frank rules. The agency’s guidance determines when regulations apply to foreign-based companies trading with U.S. clients and to branches of U.S. companies trading overseas. The reach of the rules has prompted opposition from JPMorgan Chase & Co., Goldman Sachs, Bank of America Corp. and Societe Generale SA.
Gensler urged support for the cross-border guidance, citing a need to protect U.S. taxpayers from rescuing companies whose overseas trades lead to their collapse.
“During a default or crisis, risk knows no geographic border,” Gensler said in an Oct. 30 speech prepared for a meeting held by the Ontario Securities Commission. “If a run starts on one part of a modern financial institution, almost regardless of where it is around the globe, it invariably means a funding and liquidity crisis rapidly spreads to the entire consolidated entity.”
The CFTC’s proposal failed to clarify the reach of the rules and could lead to conflicts, according to letters submitted to the CFTC by overseas regulators, including the U.K.’s Financial Services Authority, European Commission, European Securities and Markets Authority, Financial Services Agency in Japan, the Bank of Japan, Bank of France and Swiss Financial Market Supervisory Authority.
“At a time of highly fragile economic growth, we believe that it is critical to avoid taking steps that risk a withdrawal from global financial markets into inevitably less efficient regional or national markets,” George Osborne, U.K. chancellor of the exchequer, and Michel Barnier, the European Commissioner for financial services, said in an Oct. 17 letter to Gensler. “We would urge you before finalizing any rules, or enforcing any deadlines, to take the time to ensure that U.S. rule-making works not just domestically but also globally.”
The letter was also signed by Ikko Nakatsuka, Japan’s financial-services minister, and Pierre Moscovici, France’s finance minister.
“There is going to be enormous pressure for him to compromise,” Christian A. Johnson, professor at the University of Utah law school and author of a paper on the potential for regulatory arbitrage because of cross-border rules, said in a telephone interview on Nov. 5. “Industry will turn on him and international regulators have already turned on him. I don’t know how he will continue to stonewall them.”
The lack of coordination has already led to changes in how overseas firms trade with U.S. companies, according to a Nov. 2 letter from the Japan Financial Markets Council. “Some are looking at ways to avoid any transaction that might lead to a requirement to register with the CFTC. Others are simply refraining from trading,” the group said in a letter representing firms including Morgan Stanley, Bank of Tokyo-Mitsubishi UFJ and Deutsche Bank.
DBS Group Holdings Ltd, based in Singapore, and Nordea Bank AB, the Nordic region’s largest lender, have said they won’t need to register in the U.S. under Dodd-Frank rules. “We do not intend to register as a swap dealer in the U.S. because we expect our trading volumes with U.S.-based counterparties to stay below the threshold which triggers the CFTC registration requirement,” Karen Ngui, a Singapore-based spokeswoman for DBS, said in an Oct. 24 e-mail statement.
Nordea spokesman Erik Durhan said by telephone from Stockholm yesterday that the bank’s trading volumes are also below the U.S. registration requirements. “This gives us the opportunity to continue our trade without registering,” he said.
The CFTC guidance was published in two documents, including an exemptive order preventing Dodd-Frank rules from applying to certain institutions through Dec. 31.
“We need to make sure that we’re giving relief where relief is needed to market participants until we can confirm that the entire world globally is on the same page on cross-border regulations,” Sommers said.
The $648 trillion measure of the global swaps market represents the total notional amounts outstanding of over-the-counter derivatives through December 2011, according to the Bank of International Settlements, a Basel, Switzerland-based organization that promotes global financial collaboration and serves as a bank for central banks.