Extraterritorial Issues Dog Regulators

Terry Flanagan

EU legislators are poised to adopt an indemnification provision that would prevent SDRs from sharing information.

Extraterritorial issues associated with OTC derivatives reforms are threatening to impede the stated goals of increasing market transparency and mitigating risk in the OTC marketplace.

The Dodd-Frank Act requires that U.S.-based swap data repositories obtain indemnifications from foreign regulators before sharing information. The unintended consequence of this measure is that it will undermine the ability of global regulators and market participants to obtain a comprehensive and unfragmented view of market data, leading to increased systemic risk.

The Commodity Futures Trading Commission has tried to finesse the issue by permitting SDRs based in the United States to share information with their foreign counterparts without requiring indemnification, provided that the SDR is also registered with the foreign regulator, according to a final rule implementing provisions for SDRs.

The CFTC based its determination on Dodd-Frank’s directive “to promote effective and consistent global regulation of swaps.” The CFTC said it doesn’t interpret the indemnification provision to apply in circumstances where a foreign regulator possesses independent sovereign legal authority to obtain access to information and data held and maintained by an SDR.

However, the CFTC rule doesn’t eliminate the extraterritorial issues inherent in the different statutes being promulgated on both sides of the Atlantic: Dodd-Frank in the United States and European Market Infrastructure Regulation (EMIR).

Without an indemnity agreement, SDRs may be legally precluded from providing critical market data to regulators overseas, Dan Cohen, managing director and head of government relations for The Depository Trust & Clearing Corporation (DTCC), told Markets Media..

As a result, foreign jurisdictions may be incentivized to create their own local repositories to avoid indemnification – a move that would inevitably lead to data fragmentation. A proliferation of local repositories would make it extremely difficult to obtain a full picture of any particular asset class, impairing market and regulatory oversight, creating inconsistencies in market data and impeding data analysis, Cohen said.

The European Parliament is poised to adopt counter legislation in the final version of its financial reform package, meaning that U.S. regulators like the CFTC and the Securities and Exchange Commission (SEC) would likely face diminished access to information held in overseas repositories.

One option is for Congress to modify the provision in a technical corrections bill. For instance, Congress can “deem” regulatory compliance with the indemnification provision in situations where foreign regulators are carrying out their responsibilities in a manner consistent with international policy forums, such as the ODRF.

Time is growing short, however. With EMIR about to enter trialogue discussions involving the European Parliament, the European Council, and the European Commission, a final version of EMIR is likely to pass during the first quarter of 2012, at which point it will have the force of law.

“As a regulation, EMIR will go into effect without requiring member states in the EU to pass national legislation,” said Cohen. “Therefore, the issue needs to be resolved quite soon.”

Congress has begun to take action. Some Members, like Congressman Jack Kingston (R-GA) and Congressman Sam Farr (D-CA), have begun outreach to their European counterparts.

Congressman Jack Kingston (R-GA) also signaled the need for action in a recent Special Order, noting that the indemnification requirement would likely create “… fragmentation and information gaps that could meaningfully harm global safety and soundness. In light of the EU calendar on indemnification, swift action to prevent the unintended consequences of this inadequately considered provision of Dodd-Frank is needed.”

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