The largest Wall Street banks are mobilizing to fight a new policy by the U.S. Commodity Futures Trading Commission (CFTC) that gives the regulator broader authority in overseas derivatives deals.
The policy, issued Nov. 14, negates a legal interpretation that banks have been using to keep some swaps trades off electronic platforms and away from CFTC rules enacted to make the market less opaque. The firms and their lawyers say the announcement, which the agency published as a “staff advisory,” is written so broadly it could expose their overseas deals to even more U.S. regulation.
Within hours of its release, bank lobbyists met to discuss possible legal action against the agency and began contacting members of Congress, according to people involved in the pushback. The next day, CFTC Chairman Gary Gensler was getting letters from lawmakers saying he was upsetting the $693 trillion market by issuing policy with little consultation.
“These uncertainties are causing, and will continue to cause, disruptions in the OTC derivatives market,” the top Republican senators on the banking and agriculture committees, Mike Crapo of Idaho and Thad Cochran of Mississippi, wrote to Gensler on Nov. 15.
The question of how to apply U.S. derivatives rules in foreign jurisdictions has been debated since the Dodd-Frank regulatory overhaul began to take shape. The biggest banks sometimes trade half their swaps with overseas clients. Gensler has fought to extend his agency’s reach, pointing out that financial failures, including the collapse of American International Group Inc., often originate in overseas units.
Gensler defended the policy in New York today at an industry conference held by swap execution facilities (SEFs), the new platforms where most swaps are supposed to trade. He said the policy ensures equal treatment for market players.
“A U.S. swap dealer on the 32nd floor of a New York building and a foreign-based swap dealer on the 31st floor of the same building, have to follow the same rules when arranging, negotiating, or executing a swap,” Gensler said. “One elevator bank, one set of rules.”
The advisory has also reopened a rift between the CFTC and European regulators. In July, Gensler had reached an agreement with his counterparts to defer to foreign authorities when the CFTC finds their rules to be comparable—a deal seen as benefiting the largest banks.
Chantal Hughes, a spokeswoman for Michel Barnier, the European Union’s financial services chief, said the EU is examining the new policy in light of the agreement.
“At first sight, it raises concerns because of its potential extra-territorial application and impact on liquidity fragmentation,” Hughes said
The CFTC released its Nov. 14 advisory after Bloomberg News reported that banks were seeking to avoid Dodd-Frank rules by having brokers based in the U.S. arrange swap trades and book them in the banks’ affiliates overseas, handling them privately instead of on electronic platforms. Banking lawyers told brokers such moves were permissible because of language in a footnote deep in an 84-page CFTC policy statement published in July.
Under the new advisory, traders based in the U.S. who arrange, negotiate, or execute a deal—even on behalf of an overseas affiliate—must comply with Dodd-Frank regulations.
The banks’ main lobby group, the Securities Industry and Financial Markets Association (Sifma), convened an emergency conference call after the CFTC distributed the document, according to three people with knowledge of the meeting. The group discussed whether the CFTC advisory was issued lawfully and whether it should be challenged in court, said the people, who spoke on condition of anonymity because the talks were private.
Liz Pierce, a spokeswoman for Sifma, declined to comment.
Many of the banks’ complaints focused on the CFTC’s process for issuing the policy, which was drafted by staff members and hasn’t been voted on by the commissioners.
The agency also declined the banks’ request to say publicly when the policy would take effect, the people said. Agency staff told financial industry lawyers that Wall Street would be given time to adjust to the new rules.
Republican lawmakers slammed Gensler for setting regulation by fiat.
“We clearly have an agency chairman gone rogue,” said Representative Scott Garrett, a New Jersey Republican, who called the move illegal. “Since when did it become acceptable for the chairman of the CFTC to change law and commission-approved guidance though an advisory opinion issued by staff at his discretion?”
Representative Frank Lucas of Oklahoma, chairman of the House Agriculture Committee that oversees the CFTC, called on the agency to immediately issue a public statement clarifying the rules so markets wouldn’t be disrupted.
“Regulations [that] market participants thought were in place changed overnight without warning or consultation,” he said in a statement.
Steve Adamske, CFTC spokesman, declined to comment about the lawmakers’ statements.
The CFTC released a second document on Nov. 15 reinforcing the agency’s message on the applicability of overseas rules. It tells trading platforms, including those based overseas, that if they allow anyone located in the U.S. to trade on their venues that they must register with the CFTC and fall under Dodd-Frank.
More than a dozen firms have registered swap execution facilities with the CFTC, including ICAP Plc, GFI Group Inc., Tradeweb Markets LLC, MarketAxess Holdings Inc., and Bloomberg LP, parent of Bloomberg News.