U.S. banks' overseas swaps trades face new curbs under a U.S.Securities and Exchange Commission (SEC) plan adopted today, evenas some members warned the regulation may not go far enough to reinin recent Wall Street efforts to escape the Dodd-Frank Act.

The SEC voted 5-0 to extend the agency's rules to transactionsexecuted by foreign divisions of banks, including JPMorgan Chase& Co. and Goldman Sachs Group Inc., when the affiliate's tradesare legally guaranteed by the parent company. The new rule comes asWall Street has removed those guarantees to avoid Dodd-Frank Actregulations issued by another regulator, the Commodity FuturesTrading Commission (CFTC).

“The recent financial crisis is replete with examples of firmsrescuing their affiliates,” Commissioner Kara Stein said before thevote.“Firms do not jettison them off to fend for themselves intimes of crisis; they bail them out.”

U.S. regulators have faced a backlash from European and Asianauthorities for overreaching in their desire to apply Dodd-Frankrules overseas. Meanwhile, Wall Street lobbying organizations havesued the CFTC, which is the primary U.S. regulator of derivatives,to limit the international scope of the agency's power.

“The final rules and guidance have been substantiallystrengthened from our 2013 proposal to better protect the U.S.financial system from the risks that can be posed by security-basedswap activity,” SEC Chair Mary Jo White said at a publicmeeting.

Cross-border application of U.S. derivatives rules is one ofthe most contentious features of Dodd-Frank, the regulatoryexpansion enacted after the 2008 credit crisis. The law gave theSEC authority over trading in equity and some credit-default swaps,about 5 percent of U.S. swaps, while the CFTC oversees the rest:swaps on interest rates, currencies, and credit indexes.

David Felsenthal, a New York-based partner at the CliffordChance law firm, said the split oversight could cause problems forcredit-default swaps.

“It will be very difficult if there is any inconsistency to tryto mesh the two markets together,” Felsenthal said in a phoneinterview.

The SEC's final rules change its earlier approach to overseeingU.S. banks' overseas affiliates. Instead of exempting thoseentities from the rules, they will now come under the regulationswhen their overseas trades are guaranteed by a U.S. parent. Aguarantee is “a legally enforceable right” that is “in whole or inpart, oral or written, by contract or statute,” White said.

Rule Weakened

“To the extent that the new financial arrangements do not createa legally enforceable right of resource against a U.S. person, ourrules may not bring these affiliates within our regulatoryoversight,” White said.

The SEC also weakened the rules by not including a requirementto regulate swaps trades conducted in the U.S. by foreign banks andother overseas entities. The SEC said it would seek additionalcomment before adopting or rejecting the rule.

Critics of the SEC's approach faulted the agency last year fortaking a different approach than the CFTC, which oversees about 95percent of the U.S. swaps market. Others said the SEC's strategywould allow banks to escape regulation by moving more swaps dealsoffshore, which would raise the risk that an affiliate's collapsecould harm the U.S. parent company.

Advocates of stricter regulation had urged the SEC to expand itsauthority over U.S. banks' swaps trading abroad. The agency shouldhave broadened its definition of guaranteed trades to include thosewith the “implicit” backing of a U.S. parent company, according togroups such as Better Markets, a Washington-based non-profit thatadvocates for tougher financial regulation.

“They have seen how Wall Street has evaded the CFTC's rulessince last July,” said Dennis Kelleher, president of BetterMarkets. “We have spent hours with the SEC staff discussing thisand a straightforward solution: Directly prohibit de factoguarantees, Wall Street's latest tactic to avoid sensible andnecessary rules.”

The Federal Deposit Insurance Corp., which regulates Wall Streetbanks, has said it is monitoring the move by banks to remove parentguarantees from affiliates or specific transactions so they cantrade in the interdealer market free of many Dodd-Frankrestrictions. The CFTC is reviewing the overseas changes andanalyzing whether there is “evasive activity under way,”Commissioner Mark P. Wetjen said on May 14.

Market Fracturing

Under CFTC guidelines, overseas affiliates that lack a parentguarantee fall under fewer restrictions than do foreign branches orguaranteed affiliates of U.S. banks. As a result, the swaps marketis fracturing, with trades in the U.S. falling under Dodd-Frank andtrades elsewhere subject to local laws.

Trades with non-U.S. participants are occurring off of the newDodd-Frank swap-execution facilities because they are being done bythe non-guaranteed subsidiaries, John Nixon, an executive atLondon-based ICAP Plc, the world's largest interdealer broker, saidat a CFTC advisory meeting on May 21.

The U.S. House voted 265-144 to approve legislation yesterdaythat would restrict the CFTC's ability to impose rules overseas,among other changes to the agency's authority over agriculture,energy, and financial markets.

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