Wall Street, trying to preserve profits from swap trading in theface of tougher scrutiny from Washington, has found a new way tokeep some of its overseas deals private. It's called Footnote513.

Banking lawyers have seized on the wording of the footnote,contained in an 84-page policy statement issued in July by the mainU.S. regulator of derivatives. The largest banks told swap brokersin late September that the language means certain swaps still don'tfall under the agency's new trading rules, according to threepeople briefed on the discussions.

London-based ICAP Plc, one of the largest swap brokers, told thebanks it didn't agree with their interpretation, said the people,who spoke on condition of anonymity because the discussions weren'tpublic. Other brokers accepted the banks' position and have beentrading billions of dollars in contracts outside the new regulatorysystem, the people said.

The deals in question include swaps for foreign clients that arearranged by U.S.-based traders or brokers and then booked through aU.S. bank's overseas affiliate. Bank lawyers say that if the tradegoes through an affiliate it can stay private and doesn't need tobe handled on one of the public electronic trading platformsapproved by the Commodity Futures Trading Commission (CFTC), twopeople said.

Of the dozens of derivative rules being completed by the CFTC,the most contentious have involved how to oversee swaps tradedacross borders. The biggest banks sometimes trade half their swapswith overseas clients.

CFTC Chairman Gary Gensler has sought to extend U.S. authorityto those transactions, arguing that the global nature of the 2008credit crisis proved that American taxpayers could be at risk whenbanks book them in foreign units.

ICAP asked the CFTC to issue formal guidance on the debate overthe footnote, three people briefed said. The CFTC hasn't yetresponded, in part because of the 16-day government shutdown overthe budget.

Bart Chilton, one of the CFTC commissioners, said he favoredhaving the agency publish new guidelines.

“I want to ensure everyone is playing according to the samerules, and regret the lack of clarity,” Chilton said in aninterview.

Spokesmen for JPMorgan Chase & Co. and Goldman Sachs GroupInc., two of the biggest swap traders, declined to comment.Industry executives and attorneys who spoke on condition ofanonymity said the banks aren't using the footnote as a loophole toskirt the law. Rather, they are striving to interpret often-murkyguidelines, and ICAP is the only major firm to push back on theirposition, they said.

Registered Platforms

In an interview, Gensler said he was aware of the controversy.While he declined to discuss the footnote, he said swap dealersmust be careful how they interpret regulations. He said trades madein the U.S. are meant to fall under CFTC rules.

“If they're taking on transactions in New York, or Chicago orConnecticut, then that's activity related to U.S. commerce” thatshould be on a registered platform, Gensler said.

The electronic platforms, known as Swap Execution Facilities, orSefs, were created by the 2010 Dodd-Frank law to make prices morepublic and reduce risk in the system. They started trading on Oct.2. ICAP and more than a dozen other firms have registered Sefs withthe CFTC, including GFI Group Inc., Tradeweb Markets LLC,MarketAxess Holdings Inc., and Bloomberg LP, parent of BloombergNews.

Sef trading is off to a slow start as firms test the watersbefore the new rules become mandatory, according to a Goldman Sachsresearch report released yesterday. The bank's analysts estimatedthat for interest-rate swaps, the biggest part of the overallmarket, only about one-sixth of the volume has been traded onSefs.

Under the CFTC's rules, most U.S. swaps will be required byearly 2014 to trade on the platforms. The latest dust-up overFootnote 513 involves how a swap is determined to be a U.S.-relatedproduct.

The four-sentence footnote appears at the bottom of page 60 ofthe guidance the agency published in July to explain how the CFTC'srules affect U.S.-based banks doing business overseas and foreignbanks doing business in the U.S. Although the passage doesn't dealdirectly with trading rules, the banks are using it to justifytheir trading methods.

Executed Deals

The banks' assertion is focused on what the footnote doesn'tsay, rather than on what it does say. It mentions bank“branches”—which generally are part of the parent company—and not“affiliates,” which are considered legally separate.

The banking lawyers are taking the omission to mean that dealsthat are set up in the U.S. and are booked in their foreignaffiliates can escape many CFTC rules, according to the peoplebriefed on the conversations.

For example, under that interpretation traders at a NewYork-based bank could enter into a swap with a Japanese bank, usingbrokers also based in New York to set it up. As long as the deal isexecuted in the Wall Street bank's London affiliate, it wouldn'tneed to be traded on a Sef or fall under CFTC tradingregulations.

ICAP's position has been costing it business as banks take theirswaps to brokers who agree with their interpretation of thefootnote, the people briefed said. ICAP also is being cautiousabout CFTC rules after paying $65 million in September to settle anenforcement case with the agency over some of its brokers' attemptsto manipulate the Libor interest-rate benchmark, two peoplesaid.

Guy Taylor, a spokesman for ICAP, declined to comment.

Overseas Dispute

The debate highlights a long-running dispute over the parity ofswaps regulation in the U.S., Europe and Asia. Comparable tradingrules haven't been completed in European or Asian jurisdictions.The CFTC and foreign regulators also have been fighting over howmuch they will defer to each other's requirements for trades thatstretch across borders.

The overseas reach of the CFTC's rules has been one of Gensler'smost common themes since he became chairman of the agency in 2009.In a June 6 speech, he reiterated that domestic or foreign swapdealers dealing with “U.S. persons” had to comply with Dodd-Frankrules to ensure that risk accumulated somewhere else doesn't landback in the U.S.

“It was financial institutions operating complicated swapsbusinesses in offshore entities that nearly toppled the U.S.economy” in 2008, Gensler said.

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