Wall Street’s bid to rein in U.S. derivatives regulation was rejected by a federal judge in a significant victory for the government’s ability to police trading outside the country.

U.S. District Judge Paul Friedman threw out much of an industry challenge questioning the legality of Commodity Futures Trading Commission (CFTC) guidelines that extend the regulator’s reach into swap deals handled in the U.K., Japan, and other foreign countries.

The ruling “vindicates the CFTC’s view of its broad authority overseas, in response to the 2008 financial crisis,” said Julian Hammar, a former assistant general counsel at the agency who is now of counsel in the Washington office of the Morrison & Foerster law firm. “It’s an important decision.”

The question of how to apply the CFTC’s regulations overseas has been among the most contentious issues in a four-year battle pitting the largest banks, including JPMorgan Chase & Co., Goldman Sachs Group Inc., and Deutsche Bank AG, against the regulatory agency.

Under former chairman Gary Gensler, the CFTC asserted that oversight of overseas trading was necessary to prevent blow-ups at foreign-trading divisions from threatening banks and the economy in the U.S. Billions of dollars in losses at a London-based swap-trading division of American International Group Inc. prompted a taxpayer rescue of the insurer at the height of the 2008 credit crisis.

In his ruling, issued yesterday in Washington, Friedman said the CFTC acted properly under the 2010 Dodd-Frank Act in setting policies for the $700 trillion global market.

“Congress has clearly indicated” that the swaps oversight included in Dodd-Frank, “including any rules or regulations prescribed by the CFTC, apply extraterritorially,” Friedman wrote.

The judge ruled in favor of the industry challenge in one area, ordering the agency to conduct a better analysis of the costs and benefits of the extraterritorial aspects of 10 different rules.

The lawsuit—filed by the Securities Industry and Financial Markets Association along with the International Swaps and Derivatives Association and the Institute of International Bankers—was one of the highest-profile challenges to the U.S. efforts to reshape financial regulation after the worst economic collapse since the Great Depression.


Bank Challenge

Swaps have been traded behind closed doors for decades, and Dodd-Frank gave the CFTC power to bring the transactions under U.S. oversight for the first time.

The three trade associations, in a statement, said the ruling leaves uncertainties about how the CFTC rules are applied overseas that “are of significant concern to market participants.”

The industry has 60 days to appeal the decision, as does the CFTC.

The agency’s chairman, Timothy Massad, said in a statement after the ruling that he was pleased that the court “rejected a sweeping injunction of the rules that are at the heart of Dodd-Frank’s overhaul of the swaps markets.”

Massad said the agency would continue reform efforts while addressing concerns from lawmakers that risks abroad could threaten the U.S. economy.

In yesterday’s 92-page ruling, the court declined to second-guess the CFTC’s decision to spell out its oversight as guidance rather than through formal rules as sought by the three Wall Street lobbying groups that filed the suit in December.

While Friedman faulted the CFTC for failing to thoroughly study the costs and benefits of the 10 rules, he declined the industry call to vacate them. Throwing the regulations out “would be unnecessarily disruptive to the CFTC’s mission and the purposes of the Dodd-Frank Act,” the judge wrote.

Advocates of stronger regulations for Wall Street banks praised the decision.

“Proponents of financial reform secured a major victory,” said Representative Maxine Waters of California, the senior Democrat on the House Financial Services Committee. “It is in the best interests of American taxpayers that the U.S. District Court has expressed an understanding that these efforts to evade important U.S. regulations are contrary to Congressional intent, and only serve to harm consumers and our economy in the long run.”

Marcus Stanley, policy director for Americans for Financial Reform, a coalition including the AFL-CIO labor federation, said the decision should bolster the agency’s efforts to curb recent steps by Wall Street to escape Dodd-Frank by shifting their overseas trading operations.

“I really hope that this decision is going to stiffen the CFTC’s backbone,” Stanley said in a phone interview.

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

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