Wall Street Bid on Cross-Border Swaps Quashed

CFTC shuts down banks' plan to avoid Dodd-Frank rules by arranging trades in the U.S., then booking them through overseas affiliates.

The top U.S. derivatives regulator moved to close off large banks’ ability to avoid new regulation by arranging trades in America and then booking the deals in overseas affiliates.

The guidance, released yesterday by the Commodity Futures Trading Commission (CFTC), undermines a legal interpretation Wall Street had found buried in a footnote, number 513, in an agency policy document. Banks relied on the footnote to keep swap deals off electronic platforms and away from the agency’s rules that were put in place in the wake of the financial meltdown.

Yesterday’s two-page guidance, while not mentioning the footnote, effectively closes the loophole. It tells traders that if they are based in the U.S. and arrange, negotiate, or execute a deal—even on behalf of an overseas affiliate—they must comply with the CFTC regulations.

Lawyers said the new policy gives the CFTC a greater reach to police the swaps market and makes it harder for banks to keep trades away from tough U.S. regulations, passed in the 2010 Dodd-Frank Act. CFTC Chairman Gary Gensler has fought for more than four years to extend his agency’s reach, arguing that U.S. taxpayers could be on the hook for overseas blow-ups due to the global nature of the business.

The new guidance “significantly expands the CFTC’s cross-border jurisdiction,” said Annette L. Nazareth, a partner at the Davis Polk & Wardwell LLP law firm in Washington. “It also immediately throws into doubt the viability of many trading arrangements used by banks worldwide.”


Footnote 513

The issue of footnote 513 arose in October after Bloomberg News reported that several Wall Street banks, the biggest dealers of derivatives, asked their swaps brokers to set up trades in the U.S. while booking them in affiliates overseas. The banks told the brokers that the language in the footnote allowed them to avoid new Dodd-Frank rules.

London-based ICAP Plc, one of the largest swap brokers, disagreed with the banks’ interpretation. Other brokers accepted it and have been trading billions of dollars in contracts outside the new regulatory system.

ICAP asked the CFTC to weigh in on the issue last month. Guy Taylor, a spokesman for the company, said he couldn’t immediately comment because it hadn’t fully reviewed the new guidance.

The trades at issue will be conducted on electronic platforms, known as Swap Execution Facilities, or Sefs, created by Dodd-Frank in an effort to make prices more public and reduce risk in the system. They started trading on Oct. 2.

ICAP and more than a dozen other firms have registered Sefs with the CFTC, including GFI Group Inc., Tradeweb Markets LLC, MarketAxess Holdings Inc. and Bloomberg LP, parent of Bloomberg News.

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