The top U.S. derivatives regulator moved to close off largebanks' ability to avoid new regulation by arranging trades inAmerica and then booking the deals in overseas affiliates.

The guidance, released yesterday by the Commodity FuturesTrading Commission (CFTC), undermines a legal interpretation Wall Street had found buried in afootnote, number 513, in an agency policy document. Banks relied onthe footnote to keep swap deals off electronic platforms and awayfrom the agency's rules that were put in place in the wake of thefinancial meltdown.

Yesterday's two-page guidance, while not mentioning thefootnote, effectively closes the loophole. It tells traders that ifthey are based in the U.S. and arrange, negotiate, or execute adeal—even on behalf of an overseas affiliate—they must comply withthe CFTC regulations.

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

The new guidance “significantly expands the CFTC's cross-borderjurisdiction,” said Annette L. Nazareth, a partner at the DavisPolk & Wardwell LLP law firm in Washington. “It alsoimmediately throws into doubt the viability of many tradingarrangements used by banks worldwide.”

Footnote 513

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

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

ICAP asked the CFTC to weigh in on the issue last month. GuyTaylor, a spokesman for the company, said he couldn't immediatelycomment 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-Frankin an effort to make prices more public and reduce risk in thesystem. 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.

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