Thursday, February 02, 2012

SEC and CFTC Issue Joint Report on Global Swap Regulation as Mandated by the Dodd-Frank Act

As mandated by Section 719(c) of the Dodd-Frank Act, the SEC and CFTC issued a joint report describing the regulatory framework for OTC derivatives in the Americas, European Union, and Asia, and analyzing the similarities and differences across jurisdictions. Essentially, the report provides a snapshot of current efforts to regulate OTC derivatives in the Americas, Europe, and Asia and, as such, is a timely complement to ongoing efforts at the CFTC and the SEC to monitor similarities and, more importantly, differences among regulatory proposals. Regulatory developments will continue for the foreseeable future, and the Commissions will continue to address issues arising from regulatory divergence.

Broadly, the report recommends that the CFTC and SEC staffs should continue to monitor developments at the national level across jurisdictions and should communicate with fellow regulators involved in efforts to regulate OTC derivatives. The CFTC and SEC staffs should also continue to participate in international fora and actively contribute to initiatives that are designed to develop and establish global standards for OTC derivatives regulation.

Similarly, the CFTC and SEC staffs should continue to engage in bilateral dialogues with regulatory staff in the European Union, Japan, Hong Kong, Singapore, and Canada and should consider dialogues with additional jurisdictions, as appropriate. In the view of the Commissions, these recommendations provide a roadmap for successful consultation and coordination with non-U.S. authorities to promote effective and consistent international standards in the regulation of OTC derivatives.

Regulation of OTC derivatives has just begun, noted the report, and efforts to regulate them involve global financial stability, which is linked to consistent and comprehensive OTC derivatives regulatory reform. While the G-20 leaders have agreed to the OTC derivatives commitments, said the report, it is still too early to determine precisely where there is alignment internationally and where there may be gaps or inconsistencies. In the interim, the CFTC and SEC are working with other domestic and foreign regulators to analyze requirements and coordinate regulatory proposals to the greatest extent possible. The Commissions will continue to monitor global reforms and are committed to working closely with their international counterparts in this effort.

Section 752(a) of Dodd-Frank requires the CFTC and the SEC to consult and coordinate with foreign regulators on the establishment of consistent international standards for regulating swaps and swaps entities to promote effective and consistent global regulation. The Commissions have been, and will continue to be, actively involved in several international initiatives and in various international fora that are focused on the regulation of OTC derivatives. Consistent with Dodd-Frank’s mandate, the Commissions have directed staff to participate in international work streams that are developing standards for OTC derivatives regulation, as well as in fora for additional consultation and coordination.

The report noted that the European Union has started the process of creating an EU-wide regulatory framework for OTC derivatives with the European Market Infrastructure Regulation (EMIR) and amendments to the Markets in Financial Instruments Directive (MiFID). The CFTC and SEC staffs has been engaged in a regulatory dialogue with the European Commission and the European Securities and Markets Authority (ESMA) concerning differences between Title VII of Dodd-Frank and EMIR and MiFID.

EMIR is designed to increase transparency in the OTC derivatives market and reduce counterparty credit and operational risks. To this end, EMIR requires reporting of derivatives transactions to trade repositories and the clearing of eligible OTC derivatives through central counterparties. EMIR also contains measures to reduce counterparty credit risk and operational risk for bilaterally transacted OTC derivatives.

Under EMIR, as proposed, all OTC derivatives that have been declared subject to the clearing obligation would be required to be cleared through authorized or recognized central counterparties after EMIR is approved. ESMA will have primary responsibility for implementation. EMIR would require central counterparties to comply with detailed prudential, business conduct, and organizational requirements

The report noted that the Hong Kong Monetary Authority and Securities and Futures Commission proposed an OTC regulatory regime in October 2011, with an eye to adopting final regulations by the end of 2012. The Hong Kong Authorities have proposed that only a recognized clearing house or an authorized automated trading services provider should be eligible to be designated as a central counterparty. They are considering whether to require clearing by local central counterparties of products that are considered systemically important to the Hong Kong financial market.

The SFC intends to adopt international standards consistent with IOSCO for the regulation of central counterparties before recognizing an entity as a recognized clearing house or authorized automated trading services provider for OTC derivatives. These international standards include standards relating to governance structures, financial resources, membership criteria, risk management policies and procedures, margining requirements, and default procedures.


CFTC Commissioner Scott O’Malia issued a dissent to the joint report. In the commissioner’s view, although there is coordination on general policy considerations, significant questions remain regarding the extraterritorial application of specific rulemakings currently underway at the SEC and CFTC.

According to the commissioner, the application of entity definitions proposed by the CFTC would subject U.S. entities to mandatory clearing and capital requirements even if they operate outside the U.S., while foreign competitors may not be so constrained.

In addition, a number of jurisdictions object to a DFA provision indemnifying swap data repositories and the CFTC, and have demanded that if change is not made, they will not cooperate with U.S. swaps data collection efforts. Staff has noted that a statutory change may be necessary to ensure that the U.S. is able to fully cooperate with international regulators to share critical information regarding global risk exposure and trade data.

My colleague Lene Powell contributed to this post.