Swaps Rules Challenged in Court

Wall Street trade groups sue the CFTC to curb overseas reach of its regulations.

Wall Street’s biggest lobbying groups banded together to sue the Commodity Futures Trading Commission (CFTC), seeking to curb the overseas reach of its rules and rein in a regulatory barrage by its departing Chairman Gary Gensler.

The suit, filed yesterday in federal court in Washington, seeks to overturn guidance the CFTC approved in July. The trade associations, which represent Goldman Sachs Group Inc., JPMorgan Chase & Co., Deutsche Bank AG, and other swap dealers, say the agency illegally set regulations by issuing guidance documents and staff advisories rather than formal commission-approved rules.

In their court papers and in interviews, the groups said they felt pushed to the edge by Gensler, who has spent the past five years grappling with banks over the parameters of a more public marketplace for financial products that helped ignite the 2008 credit crisis.

The policies have been championed by “a single individual in a single agency by what amounts to individual fiat,” said Judd Gregg, chief executive officer of the Securities Industry and Financial Markets Association (Sifma), one of the organizations that brought the case. “You can’t allow that sort of precedent to stand,” Gregg said in an interview yesterday.

The industry decided to go to court as a “last resort,” to end a “very disruptive process which is outside the rule of law,” he said.

Gensler defended the CFTC’s policies, saying the overseas guidance was released appropriately. “I feel very good about what we did,” Gensler said today in an interview on NPR’s “On Point” radio program. “It’s not surprising that there are challenges here because there is a lot of money at stake.”

The lawsuit—filed by Sifma along with the International Swaps and Derivatives Association and the Institute of International Bankers—is the latest in a series of Wall Street challenges to U.S. efforts to reshape financial regulation after the worst economic collapse since the Great Depression. The 2010 Dodd-Frank Act gave the CFTC power to bring swaps, which have been traded behind closed doors for decades, under U.S. oversight for the first time.

The question of how to apply the new regulations overseas has been among the most contentious issues in the battle between the banks and Gensler, a former Goldman Sachs partner, over the $693 trillion global derivatives market.

The biggest banks conduct at least half their swaps business with overseas clients, according to some estimates. Gensler has fought to extend his agency’s authority into foreign transactions, pointing out that several major financial failures, including the collapse of American International Group Inc., originated in overseas units.

The CFTC first approved the guidelines for overseas swaps in July. In November the agency issued two staff opinions to clarify the scope of the guidelines.


Foreign Swaps Rules May Slow

The lawsuit focuses on the often arcane way that agencies set policy. Formal agency rules require cost-benefit analysis and votes by commissioners, who are picked by the president and confirmed by the Senate. The guidance document in July, which was approved in a commission vote, lacked economic analysis. The advisories in November lacked both economic analysis and a formal vote.

The November documents “turned on its head assumptions the market had been making,” ISDA Chairman Stephen O’Connor said in an interview.

While the groups asked the court to vacate the CFTC policy, the case could have the practical effect of slowing the foreign trading rules.

According to one person briefed on the ISDA board meeting when the suit was authorized last month, the association’s attorneys said they would consider it a victory if the guidance was delayed for a year.

The person, who asked for anonymity because the meeting was private, said ISDA Chief Executive Officer Robert Pickel told the board that while there was a potential the case would push the CFTC to take an even stronger stance against Wall Street, joining the other trade groups would highlight the strength of the opposition.

Pickel declined to comment on what he said at the meeting.

The trade associations hired Gibson, Dunn & Crutcher LLP partner Eugene Scalia, who specializes in challenging regulations and has won cases involving Dodd-Frank rules issued by the CFTC and the Securities and Exchange Commission (SEC).

Rulemaking Rules

The agency’s use of guidance and staff advisories violated federal laws that lay out requirements for rulemaking, including performing an analysis of the costs and benefits, the groups said in their lawsuit.

“The commission attempted to excuse itself from those requirements by issuing a sweeping, international compliance directive that it characterized as mere guidance,” they said.

The industry also argued that the November advisories fundamentally changed the policy the CFTC released in July—guidelines they said they had already bent over backward to follow.

The July policy contained a footnote, number 513, that banks were relying on to keep swap deals off electronic platforms and away from the agency’s rules. The Nov. 14 advisory was published after Bloomberg News reported on the banks’ use of the footnote loophole.

The advisory explained that 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.

Gensler’s move in November drew support from Senator Carl Levin, a Michigan Democrat who has investigated Wall Street trading practices. He said the advisories were necessary to close off an “offshore gimmick” banks used to evade oversight.

Republican lawmakers have been critical of Gensler’s effort.

“This lawsuit comes in direct response to Chairman Gensler’s decision to ignore the rule of law and disregard long- established procedures at the CFTC for adopting new rules,” Representative Frank D. Lucas, an Oklahoma Republican and chairman of the House committee that oversees CFTC, said in a statement yesterday.

The banks say they are concerned that, along with its potential to disrupt current deals, the language in the opinion is so broad that it could expose overseas trades to even more regulation. They also said the advisory went against a deal Gensler cut with EU regulators to divide up swaps oversight abroad.


EU ‘Surprised’

Michel Barnier, the European Union’s financial services chief, expressed reservations about the CFTC’s moves last month. His spokeswoman, Chantal Hughes, said Nov. 20 that “we were very surprised by the latest CFTC rules, which seem to us to go against both the letter and spirit” of the division of oversight agreement Gensler hammered out with the EU in July.

Bloomberg LP, parent of Bloomberg News, operates a trading platform known as a Swap Execution Facility and unsuccessfully sued the CFTC on different rules.

The case is SIFMA v. U.S. CFTC, 13-cv-1916, U.S. District Court, District of Columbia (Washington).

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