Extraterritorial Issues Assessed

Terry Flanagan

Global nature of financial markets could clash with multiple regulatory regimes.

Extraterritorial issues are etching their mark on the tapestry of issues associated with financial market reforms taking place on both sides of the Atlantic.

In Europe, MiFID II delegates powers to the European Securities and Markets Authority to allow third country (e.g., non-EU) firms to operate in the EU without setting up a branch in the EU, provided that the third country provides access to EU-based firms on a reciprocal or “equivalent” basis.

The equivalency test will replace the U.K.’s existing regulatory exemptions for overseas financial firms, and hence threaten their ability to access the U.K.

“Despite the U.K.’s fear that the ‘Fortress Europe’ approach may be potentially damaging to the functioning of global markets, the European Commission seems set on these third country rules,” said a report by SNR Denton LLC.

Under the Dodd-Frank Act, the Securities and Exchange Commission and the Commodity Futures Trading Commission are required to jointly study and report to Congress on swap regulation and clearinghouse regulation in the United States, Europe, and Asia, and to identify areas of regulation that need to be harmonized.

A major part of the report, which by law must be produced no later than March 2012, will be devoted to a comparison of the different regulatory regimes.

The questions being posed by the SEC and CFTC frame the differences across national boundaries, and seek to ascertain whether such differences should be harmonized.

The report must identify major dealers, exchanges, clearinghouses, clearing members, and regulators in each geographic area and describe the major contracts (including trading volumes, clearing volumes, and notional values), methods for clearing swaps, and systems used for setting margins.

A group of money center banks, all of them major swaps dealers, have outlined recommendations to the SEC and CFTC on international issues related to Title VII of Dodd-Frank, which covers OTC derivatives.

The banks are recommending that the SEC and CFTC take into account the fact that non-U.S. firms have conducted swap activities with U.S. persons, and vice versa, for many years, including through non-U.S. branches and affiliates, that many non-U.S. jurisdictions already regulate swaps dealers, including non-U.S. branches and affiliates of U.S. and non-U.S. firms, and the G-20 jurisdictions are working to supplement their existing regulatory regimes to incorporate derivatives-related clearing and market transparency reforms to achieve regulatory objectives similar to those of Dodd-Frank.

A non-U.S. person should not be deemed a U.S. swap dealer solely as a result of executing swaps with U.S.-registered swaps dealers, the banks said.

Dodd-Frank states that provisions relating to swaps will not apply to activities outside the U.S., unless those activities “have a direct and significant connection with activities” in the U.S.

CFTC chairman Gary Gensler has stated that the final swap dealer registration rule would likely not take into account swap transactions between non-U.S. entities outside of the U.S., but that it could include transactions between U.S. entities outside of the U.S., particularly if an entity is guaranteed by a U.S. parent.

“A non-U.S. commodity dealer could thereby become subject to duplicative and potentially conflicting regulatory regimes,” according to SNR Denton.

Certain proposed Dodd-Frank rules could potentially place non-U.S. swap dealers that are subsidiaries of U.S. persons at a competitive disadvantage when compared with non-U.S. swap dealers that don’t have a U.S. affiliate, the report said.

Similar approaches have been adopted in other directives, such as the Alternative Investment Fund Managers Directive (AIFMD), the report noted.

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