EU and CFTC Seek Common Ground on Derivatives

Terry Flanagan

Regulators for the European Union and the United States have announced “joint understandings” on a package of measures for how to approach cross-border derivatives.

For bilateral nucleated swaps, the Commodity Futures Trading Commission plans to issue no-action relief for certain transaction-based requirements. In this regard, the EU’s system of ‘equivalence’ can be applied to allow market participants to determine their own choice of rules.

For the trading-execution requirement, the CFTC plans to permit foreign boards of trade that have received direct access no-action relief to also list swap contracts for trading by direct access to avoid market and liquidity disruption.

“With these joint understandings, together, we’ve taken another significant step in our mutual journey to bring transparency and lower risk to the swaps market worldwide,” said CFTC chairman Gary Gensler.

Final rules adopted to implement the derivatives portions of the Dodd-Frank Act and Emir are essentially identical, even though the regulatory calendars are not always synchronized, the CFTC said in a statement.

However, as the market subject to these regulations is international, subjecting the global market to the simultaneous application of each other’s requirements without coordination could lead to conflicts of law, inconsistencies, and legal uncertainty.

“Our discussions have been long and sometimes difficult, but they have always been close, continuous and collaborative talks between partners and friends,” said European Commissioner Michel Barnier.

The CFTC will extend appropriate time-limited transitional relief to certain EU-regulated multilateral trading facilities (MTFs), in the event that the CFTC’s trade execution requirement is triggered before March 15, 2014.

Such relief would be available for MTFs that have multilateral trading schemes, a sufficient level of pre- and post-trade price transparency, non-discriminatory access by market participants, and an appropriate level of oversight.

The CFTC seeks to issue final guidance on the cross-border application of its requirements setting out how its rules apply to cross-border swaps activities. For requirements that are applicable at the entity level, the CFTC has proposed that substituted compliance will be permitted for the requirements applicable in the EU that are comparable to, and as comprehensive as, those applicable in the U.S.

The CFTC and EU have essentially identical processes with regard to adopting mandatory clearing obligations. When the EU adopts its first mandatory clearing determination beginning next year, it is likely to cover the same classes of interest rate swaps and credit default swap indices as the CFTC’s determination.

The regulators have agreed to adopt a ‘stricter-rule-applies’ approach to cross-border transactions, where exemptions from mandatory clearing would exist in one jurisdiction but not in the other. This will prevent loopholes and any potential for regulatory arbitrage.

With respect to central counterparties (CCPs), CFTC rules and Emir are both based on international minimum standards. CCP initial margin coverage is the only key material difference and the parties will work together to reduce any regulatory arbitrage opportunities. They will also endeavor to ensure that CCPs that have not yet been recognized or registered in the U.S. or the EU will be permitted to continue business operations.

For reporting trades to trade repositories, the regulators have determined that their approaches are very similar and will continue to work with each other to resolve remaining issues, such as consistent data fields, access to data, and other issues related to privacy, blocking, and secrecy laws. They will seek to resolve any material issues that may arise in line with the conclusions that may be drawn from discussions in international forums on this subject.

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