U.S. to Study Global Swaps Regulations

Terry Flanagan

United States regulators have embarked on a study of international swap regulations with a view toward establishing some consistency across jurisdictions.

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.

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

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.

“In principle, the G20 agreed to concepts that are at the heart of the Dodd-Frank Act, but in practice it’s proving to be very difficult,” Andrew Cross, partner in the financial institutions group at Reed Smith, told Markets Media.

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 are differences in philosophy between the SEC and CFTC themselves that need to be resolved.

For example, proposed minimum capital requirements being considered by the CFTC would limit the use of so-called internal models for calculating the amount of capital a swaps dealer or major swaps participant would be required to maintain.

The SEC currently reviews and approves capital models for alternative net capital broker-dealers and OTC dealers. Given the competitive disadvantages that non-model-eligible swap entities would face, the CFTC is being urged to develop similar expertise to review and approve these entities’ internal capital models.

“As the lines increasingly blur between different participants in the marketplace, including non-bank and bank dealers, it is critical that the new regulatory framework provide a level playing field that encourages competition and new entrants,” Rohan Douglas, founder and CEO of Quantifi, told Markets Media. “This is the best way to ensure transparency and efficiency in the OTC markets going forward.”

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.

For example, the development of global trade repositories for OTC swaps, at its embryonic stage, is being impeded by frictions among regulators about whether or under what conditions they will be granted unfettered access.

Both Dodd-Frank in the United States and EMIR in Europe have as core tenets the establishment of repositories to provide regulators and the industry with an overall view of risk exposures.

The paradox is that even as trade repositories for OTC swaps are being created or retooled to meet regulatory demands for post-trade transparency, the same regulators appear to be erecting barriers to transparency.

Dodd-Frank currently requires U.S. based swap data repositories (SDRs) to obtain indemnification from foreign regulators before sharing information. There is a concern that foreign regulators will be unlikely to grant this indemnification, which could result in a proliferation of local swap data repositories.

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.

One question reads: “Assuming that a theoretically optimal set of regulations for a particular jurisdiction might take into consideration elements unique to a specific market, to what extent do the benefits of greater harmonization outweigh the costs associated with having less-tailored regulations?”

The joint SEC-CFTC report will entail a good deal of fact gathering, for which the agencies are relying upon other regulators as well as market participants. For example, 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.

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