Overseas Regulators Up in Arms Over U.S. Swap Rules

Terry Flanagan

The extraterritorial implication of new U.S. rules concerning derivatives trading continues to cause concern to regulators across the globe.

A host of complaints have been directed to the U.S. Commodity Futures Trading Commission (CFTC) from foreign counterparts, saying that the U.S. is overstepping its authority and jurisdiction concerning swap contracts.

In a rare move, Singaporean, Hong Kong and Australian bodies have come together to write a letter to the CFTC warning that the U.S. over-the-counter derivatives reforms, which will be enacted through the Dodd-Frank Act, will bring extraterritorial implications for their organizations as well as increase cost, complexity, fragmentation and risk for market participants in international markets.

“We are concerned that some of the proposed requirements as they currently stand may have significant effects on financial markets and institutions outside of the U.S.,” said the letter, which was signed by the Australian Securities and Investments Commission, the Hong Kong Monetary Authority, the Monetary Authority of Singapore, the Reserve Bank of Australia and Hong Kong’s Securities and Futures Commission.

“We believe a failure to address these concerns could have unintended consequences, including increasing market fragmentation and, potentially, systemic risk in these markets, as well as unduly increasing the compliance burden on industry and regulators.”

This is the latest snub by international regulators over the CFTC’s plans, following on from recent complaints by regulators in Japan, France and Switzerland. The U.K.’s Financial Services Authority has also asked the CFTC to delay the new swap rules for at least another six months so that regulators can iron out any inconsistencies together.

And the European Commission has warned that the proposed U.S. swap rules could “lead to duplication of laws and to potentially irreconcilable conflicts of laws for market operators”.

The reason for the overlap of rules is because different jurisdictions are currently in the process of writing and implementing new regulations that the G20 group of nations wants introduced globally by the end of this year in a bid to reform the opaque $700 trillion OTC derivatives market following the collapse in September 2008 of U.S. investment bank Lehman Brothers, a heavy derivatives user, and resultant global financial crisis.

The aim is to standardize many OTC derivatives contracts and push them on to exchange-like venues where they will be cleared centrally and reported to trade repositories in a bid to improve transparency and mitigate systemic risk. The G20 demanded that this process be complete by the end of this year, although it appears that this deadline may not now be met.

In Europe, the European Market Infrastructure Regulation (Emir), which is the European Union’s attempt at better regulating the region’s OTC derivatives markets, is not now likely to be in place before July 2013 at the earliest, according to market sources, while Dodd-Frank is further advanced following the publication of swap definitions last month, which initiated a 60-day countdown for compliance to key parts of the Act. Asia, meanwhile, is more up in the air as there is no single regulator overseeing the region.

“There are a number of different approaches between regulators,” Dr Christian Voigt, business solutions architect at Fidessa, a trading technology company, told Markets Media.

“But there is the real risk that a number of large international players will face massive overheads because they have to adhere to multiple regulations.”

Voigt also warned that regulatory gaps will need to be closed to avoid arbitrage between Europe, the U.S. and Asia-Pacific. He foresees that many firms may head out to Asia to capitalize on more lenient regimes.

“Europe, especially, needs to be very careful on how it goes forward on this,” said Voigt. “It is definitely a huge risk, especially for Europe, which is facing considerable economic challenges and could potentially lose out to the global markets.”

The CFTC, which aims to roll out the Dodd-Frank regulation from October 12, has not yet responded to the concerns of overseas regulators on extraterritoriality and with the CFTC’s new rules for swap dealers and major swap participants— where dealers, and potentially other financial institutions, will have to register with the CFTC to adhere to new codes of conduct and trade reporting—still at the proposed guidance stage, some market participants feel that the CFTC’s October deadline may also slip. Currently, all foreign firms intending on conducting swap business with U.S. firms have until October 12 to register with the CFTC to become compliant with the new rules.

However, CFTC chairman Gary Gensler adopted a no-nonsense stance in June when issuing the swap proposals. “There are some in the financial community who might want the CFTC to ignore the hard lessons of the crisis,” he said.

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