Japan Weighs In on Dodd-Frank

Terry Flanagan

Japan is weighing in on the scope of OTC regulations in the United States, as Japanese capital markets firms are gearing up for the transition to centrally cleared OTC derivatives transactions.

In Japan, in relation to yen interest rate swaps, a mechanism of indirect clearing participation for eligible central counterparties (CCPs) has not yet been established, and eligible CCPs defined in the U.S. regulations are not yet authorized for Japan.

“As such, there is a concern that Japanese financial institutions may not satisfy the central clearing mandate under both applicable Japan and U.S. regulations, giving rise to a possibility of Japanese financial institutions not being able to execute a swap transaction,” said the Japanese Bankers Association in an August 21, 2013 letter to the U.S. Commodity Futures Trading Commission.

In order to facilitate swap transactions in the cross-border swap markets, such inconsistency should be eliminated at an earlier stage, said the JBA. Inconsistencies should be addressed on a case-by-case basis, such as publishing a No-Action Letter that allows the application of a substituted compliance.

The letter was sent in response to the CFTC’s exemptive order regarding compliance with certain swap regulations, which was proposed on July 12, 2013. The order provides that requirements may be delayed until the earlier of December 21, 2013, or 30 days following the issuance of a substituted compliance determination for the relevant regulatory requirements of the jurisdiction in which the non-U.S. swap dealer is established.

The competitive impact on U.S. registered swap dealers operating abroad will be highly dependent on the CFTC’s process for making substituted compliance determinations.

“While we support the concept of substituted compliance, we remain concerned with how this concept will work in practice, and with the potential negative competitive impacts on U.S. swap dealers, particularly dealers in foreign exchange,” said Stefan Gavell, head of regulatory, industry and government affairs at State Street Corp.

Standard swaps trading documentation is not common for FX. Such trading is largely very short-term and in the case of State Street’s business, often with existing custodial clients, and so has not typically involved exchange of margin and the type of credit support common in other swaps markets.

By requiring such documentation, the CFTC regulations would result in a shift of many non-U.S. person counterparties away from trading with U.S.-based swap dealers, said Gavell.

It is expected that OTC client clearing will be mandated in 2014 in Japan, whereas in the United States, the majority of derivatives end users were required by the Dodd-Frank Act to clear OTC derivatives beginning June 10, 2013.

Japan Securities Clearing Corporation (JSCC) began clearing CDS transactions and IRS transactions in July 2011 and October 2012, respectively, in line with global initiatives to improve market safety and transparency following the financial crisis. IRS transaction clearing volumes are steadily increasing; outstanding balances have reached over JPY 320 trillion, according to a report by JSCC.

According to a survey on OTC clearing conducted by Calypso Technology at its recent Japanese Market Forum 2013 in Tokyo, 80% of respondents are working on achieving operational readiness for OTC clearing in Japan, and 20% are already operationally ready, even though it is not mandated.

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