Regulators Stymied by Competing Legislation

Terry Flanagan

Efforts to develop a unified, global framework for OTC infrastructure are being hampered by competing regulations across jurisdictions, market participants say.

While global regulators seek to seek to adopt standards for critical financial market infrastructure such as CCPs and trade repositories, national and supranational legislation in the U.S. and Europe is being viewed as an obstruction.

Market participants are demanding a greater level of regulatory coordination to avoid duplicative or even contradictory requirements that, on the basis that the highest or most stringent standard will apply, has the potential to significantly constrain business models that have flourished within a global marketplace,

“Regulators are wrestling with the challenge of creating legislation to stabilize local markets without disadvantaging market participants in international markets, recognizing that any regional mandate has the potential of creating market fragmentation and introducing provisions that are extra-territorial in nature,” Ryan Baccus, director at Sapient Global Markets, told Markets Media.

OTC reforms had been delineated at a meeting of the G20 in Pittsburgh in 2009, which mandated that reforms be in place by the end of 2012, but the need to reconcile the Dodd-Frank Act with other supranational regimes makes that problematic.

“Lack of explicit direction around implementation and associated timelines in the G20 agreement has the potential to significantly impact the operation of capital markets as we know them,” said Baccus.

“In the absence of consistent timing and eligibility; financial institutions with cross-border activities now have to determine which regulations they will be subject to and from which national and global supervisory bodies,” he said.

A consultative report issued earlier this year by the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) enunciates principles designed to apply to all systemically important payment systems, central securities depositories, securities settlement systems, central counterparties and trade repositories (collectively “financial market infrastructures” or “FMIs”).

However, the derivatives industry is concerned about the absence of details on how the proposed CPSS/IOSCO principles will interaction with other regulatory initiatives impacting FMIs and the derivatives markets, including the U.S. Dodd-Frank Act and the European Union’s EMIR legislation on OTC derivatives, central counterparties and trade repositories.

Diverse and inconsistent requirements between different supervisors will increase costs and make it less likely that robust international standards can be developed, the International Swaps and Derivatives Association said in a comment letter.

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 joint SEC-CFTC report, which by law must be produced no later than March 2012, will be devoted to a comparison of the different regulatory regimes.

“The CFTC and SEC are both spending time this summer studying the extraterritorial impact of their rules in connection with preparing various final rules,” Joel Telpner, partner in the securities

and derivatives practice at Jones Day, told Markets Media. “Dodd-Frank requires that regulators take into account the regulatory regimes in other countries in connection with considering the impact of new U.S. rules on U.S. competitiveness and in connection with potential areas of harmonization with the rules in other countries.”

The task is complicated by the fact that the U.S. is far ahead of other jurisdictions in crafting a new swaps regulatory regime.

Under the Dodd-Frank Act, many of the required regulations with regard to swaps have been proposed, whereas European Markets Infrastructure Regulation (EMIR) on clearing and trade repositories is still being dissected by European legislators, and in Japan, regulations on OTC derivatives won’t be implemented before the end of 2012.

“There will undoubtedly be differences in the regulatory approaches taken by different countries,” said Telpner. “Some of those differences can, over time, be minimized through regulatory harmonization.”

Regulators will seek to resolve differences resulting in incompatible regulatory requirements that may make it impossible for global players to simultaneously comply with competing but inconsistent regulatory requirements. Other differences, however, that reflect different regulatory philosophies, are likely to persist and will represent differences global markets will have to live with.

“Some of these differences may create regulatory arbitrage opportunities,” said Telpner. “Other differences may simply increase the costs and complexities of conducting certain global businesses.”


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