J. Christopher Giancarlo, chairman of the Commodity Futures Trading Commission, will soon be issuing a white paper to improve deficiencies in the US regulator’s approach to overseeing cross-border activities and will cover non-US central counterparties, trading venues and swap dealers.

Giancarlo gave a speech to the the City of London Corporation yesterday evening.

Delighted to welcome @CFTC Chairman @giancarloCFTC to Guildhall this evening for an important speech on cross-border swaps regulation pic.twitter.com/oD3Otj079m

— Catherine McGuinness (@City_McGuinness) September 4, 2018

He apologised for overreach by the CFTC in applying its swaps rules outside the US, which has resulted in a number of problems, and said the regulator will publish a white paper in the near future.

The regulator published cross-border swaps guidance in 2013 and applied its transaction rules to swaps traded by US persons globally. Giancarlo continued this alienated many overseas regulators and squandered important American leadership and influence in global reform efforts.

“This white paper will assess the CFTC’s application of its swaps rules to cross-border activities and make concrete recommendations for improvements,” he added. “In a number of areas, the white paper will recognize deficiencies in the CFTC’s current approach to regulating cross-border activities and seek to recalibrate the CFTC’s cross-border approach based on a set of guiding principles.”

Rise of central clearing 

Giancarlo explained that the regulatory landscape is very different from 2013 and before the financial crisis. Since then non-US jurisdictions had made progress in finalizing the changes that were agreed at the Pittsburgh G20 Summit, particularly in central clearing, which he said is probably the most far-reaching and consequential reform.

“The default risk of swaps counterparties that was once spread across Wall Street is now pooled and managed within regulated central counterparties,” he said. “This is a significant achievement. I would say we are not in Kansas anymore (for those of you who recognize the reference), but as the chairman of the CFTC I have developed a certain fondness for Kansas, so I will simply say we are not in 2008 – or even 2013 – anymore.”

The commissioner compared the current CFTC framework as “Swaps Reform Version 1.0,” similar to the first version of a software application, and said Version 2.0 is required.

“The goal is to develop the next version of cross-border rules, which would be better calibrated to address systemic risk while fostering innovation, competition, and international cooperation,” he added. “Moreover, the CFTC should adopt proper and final cross-border rules rather than rely on less clear cut interpretive policy statements or guidance.”

The proposals will take account of the increased swaps trading data that the CFTC now receives concerning US-related trading activity and the potential build-up of risk in US-related entities.

The first principal will be the CFTC recognizing the difference between swaps reforms that are designed to mitigate systemic risk and those that address local market structure and trading practices – such as public trade reporting and price transparency, trading platform design, trade execution methodologies and mechanics, platform personnel qualifications, and examinations and regulatory oversight.

“To provide just one example, whether or not a non-US trading venue has functionality that requires a request for quote to three dealers or ten dealers has almost nothing to do with the transference of counterparty risk to the US financial system,” he said.

The second principal will be that the CFTC should use compliance with regulations in other jurisdictions as a substitute for compliance with the relevant CFTC regulations.

“Regrettably, the way in which substituted compliance of swaps reform has been implemented to date by the CFTC raises concerns,” he added. “The CFTC and its global counterparts should recommit themselves to working together to implement a deference process (using, for example, the tools of equivalence and substituted compliance), particularly for swaps execution and the cross-border activities of swap dealers, based on common principles in order to increase regulatory harmonization and reduce market balkanization.  The future of the global swaps marketplace depends on it.”

Brexit

The regulation of clearing has come to the fore since the European Union proposed that systematically important clearing houses that clear euro derivatives have to be located in the trading bloc after the departure of the UK.

Carla Jane Findlay-Dons, chief global regulatory and market strategist at Brown Brothers Harriman, said in a recent blog: “The CFTC has grown increasingly agitated with the EU as it tries to harmonize the rules to the benefit of global trade.”

Giancarlo said in a speech in May that he was worried about US CCPs being subject to overlapping EU regulation and supervision without due deference to CFTC oversight. The EU and the CFTC agreed a common approach to regulation in 2016 to ensure that global liquidity was not fragmented.

“We spent three years working on that agreement and remain committed to it,” he said. “We do not want to renegotiate it.”

Findlay-Dons suggested that after Brexit, the UK would be free to change its rules to match that of the US, the largest over-the-counter market, and foster increased activity between both countries rather than just trying to appease the EU.

One of the recommendations in the forthcoming CFTC white paper will include extending its 2016 agreement with the EU to other jurisdictions with comparable requirements for swaps CCPs and trading venues. Other recommendations will include exempting non-US CCPs that do not pose substantial risk to the US financial system from having to register with the CFTC and changing the requirements for non US persons to register as swap dealers.

“This approach will avoid incentivizing non-US market participants from avoiding financial firms bearing the scarlet letters of “US person” in order to steer clear of the CFTC’s regulations,” concluded Giancarlo. “ Furthermore, this approach will help reduce the current fragmentation of global swaps markets between US persons and non-US persons.”