Thursday, June 16, 2011

SEC Chair Addresses Dodd-Frank Regulatory Arbitrage Concerns at House Oversight Hearing

As Congress becomes increasingly concerned with issues of regulatory arbitrage and US competitive disadvantage around Dodd-Frank regulatory implementation, SEC Chair Mary Schapiro said that the SEC has been actively engaged with international securities and market regulators through informal conversations and more formally through participation in various international task forces and working groups and encouraging coordination and limiting opportunities for regulatory arbitrage. In testimony before the House Financial Services Committee, she noted that the SEC staff has encouraged international securities regulators that are contemplating OTC derivatives market reforms to use the Dodd-Frank Act and its regulations as a model for developing robust and complementary regulatory regimes.

Because the OTC derivative marketplace already exists as a functioning global market with limited oversight or regulation, said the Chair, international coordination is needed to limit opportunities for cross-border regulatory arbitrage and competitive disadvantages, and to address unnecessarily duplicative and conflicting regulations. The overall goal is to reduce systemic risks, increase transparency, and improve the integrity of the OTC derivatives marketplace, while mindful of the potential effects on efficiency and liquidity.

The Dodd-Frank Act specifically requires the SEC, the CFTC, and the prudential regulators to consult and coordinate with foreign regulators on the establishment of consistent international standards with respect to the regulation of OTC derivatives in order to promote consistent global regulation.

Rather than addressing the international implications of the derivatives provisions of Dodd-Frank piecemeal, Chairman Schapiro said that the SEC is considering addressing the relevant international issues holistically in a single proposal. Such a release would give investors, market participants, and foreign regulators an opportunity to consider the SEC’s proposed approach to the registration and regulation of foreign entities engaged in cross-border transactions involving the U.S. as an integrated whole. In her view, this approach should generate thoughtful and constructive comments for the SEC to consider regarding the application of Title VII to cross-border transactions.

In September of 2009, the G20 Leaders agreed that all standardized OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by the end of 2012 at the latest, and that OTC derivatives contracts should be reported to trade repositories. Chairman Schapiro explained that the G20 deadline contemplates that every G20 country will have completed the legislation, rulemaking and implementation of these reforms by the 2012 deadline.

Although U.S. action on OTC derivatives presents an opportunity to shape the OTC derivatives regulatory landscape, said the SEC Chair, the Commission faces challenges in negotiating with non-US regulators who have limited scope to commit to regulatory coordination before their own legislative and regulatory frameworks have been established.

While progress is being made internationally, noted Chairman Schapiro, other jurisdictions lag behind US efforts. Apart from the United States, only Japan has enacted OTC derivatives reform legislation since the September 2009 G20 Communiqué, and its legislation only covers clearing and reporting, not mandatory trading. In the European Union, legislation is currently being considered that would establish criteria for the mandatory clearing of eligible OTC derivatives contracts, rules on risk mitigation for OTC derivatives contracts that are not centrally cleared, reporting obligations to, and registration requirements for, trade repositories, and organizational requirements for central counterparties.

The proposed legislation is expected to be enacted before year-end 2011, with draft implementing regulations to be proposed to the European Commission by the market regulator by the end of June 2012, at the earliest. With regard to mandatory trading and post-trade reporting, the European Commission published a consultative paper in December 2010 on the issue of moving OTC derivatives trading to exchanges and electronic platforms and establishing post-trade requirements. A legislative proposal in this area has yet to be released.

After proposing all of the key rules under Title VII, the SEC intends to consider seeking public comment on a detailed implementation plan that will permit a roll-out of the new securities-based swap requirements in an efficient manner, while minimizing unnecessary disruption and costs to the markets.

With regard to Dodd-Frank’s registration requirements for hedge fund and private equity fund advisers, the SEC Chair noted that the Act contains an exemption from registration for foreign private advisers. Next week, the Commission will consider final rules that, among other things, would clarify the meaning of the foreign private adviser exemption

In implementing the new registration requirements and exemptions for foreign advisers provided under the Act, the Commission has sought to protect U.S. investors and the functioning of U.S. markets while minimizing potential conflicts with foreign regulation. These rules are intended to provide certainty to foreign advisers who are eager to determine their registration and compliance requirements under U.S. law.

Staff members are also analyzing comments in response to the joint proposal of the SEC and CFTC for private fund reporting. In developing this proposal, the staffs of the Commissions drew heavily on the experience and input of foreign regulators which had conducted or were developing reporting standards for hedge funds. Commission staff are continuing to coordinate with the European Securities and Markets Authority, the U.K. Financial Services Authority and IOSCO to seek comparability of data and the consistency of reporting requirements.