House Oversight Chairs Urge Treasury to Coordinate Domestic and International Dodd-Frank Derivatives Regulation to Avoid Confusion and Duplication

In a letter to Treasury Secretary Tim Geithner in his capacity as Chair of the Financial Stability Oversight Council, House oversight chairs asked him to intervene before October 12 and provide clarity and certainty for US derivatives and financial markets by delaying implementation of certain CFTC actions or providing broad exemptive relief in order to prevent the destabilization of US swap markets. The Chairs alluded to widespread confusion and uncertainty among market participants regarding exactly how the CFTC plans to implement a variety of new rules adopted under Title VII derivatives provisions of the Dodd-Frank Act with an October 12 compliance deadline.

The House Oversight Chairmen noted that Section 112 of the Dodd-Frank Act requires the FSOC to monitor domestic and international financial regulatory developments while making recommendations in such areas that will enhance the integrity, efficiency, competitiveness, and stability of the financial markets. Without global coordination, warned the House leaders, US market participants will be permanently disadvantaged if their business is siphoned away by foreign competitors, which could significantly impair US markets. The letter was signed by Agriculture Committee Chair Frank Lucas (R-OK), Commodities and Risk Management Subcommittee Chair K. Michael Conaway (R-TX), Financial Services Committee Chair Spencer Bachus (R-AL) and Capital Markets Subcommittee Chair Scott Garrett (R-NJ). The letter was copied to CFTC Chair Gary Gensler and SEC Chair Mary Schapiro.

For one thing, the House Chairmen said that foreign exchange swaps must be exempt from the cap imposed by the rules implementing Title VII’s swap dealer registration, mandatory clearing, and exchange trading requirements. The House leaders said that Treasury has exclusive authority to make this decision; and they urged Treasury to finalize rules that exempt FX swaps as soon as possible so that financial institutions can make informed decisions and restore certainty to the FX marketplace. 

The letter also noted that the CFTC issued its own interpretive guidance on the cross-border application of Title VII without coordinating with the SEC despite having no Dodd-Frank mandate for such a separate course of action. This raises the specter of two separate regulatory regimes governing swaps and security-based swaps. The House leaders urged the CFTC to avoid the illogical creation of a disparate regulatory environment resulting in the same market participant being deemed a ``US person’’ for trading swaps while simultaneously being considered a ``non-US person’’ for trading security-based swaps.

In addition, many international regulators and bodies have written to the SEC suggesting a serious lack of coordination between the CFTC and its foreign counterparts. For example, in a letter to the CFTC, the European Commission said that the broad definition of US person in the CFTC’s proposed guidance on cross-border application of the Dodd-Frank derivatives provisions poses a significant risk of the duplication of US regulatory requirements with those of the EU. Under the guidance, an EU dealer could be subject for the same trade to both EU and CFTC regulations, and a collective investment vehicle managed from the EU, but with a majority ownership by US persons, would be subject to regulations in the EU and Dodd-Frank in the US.  

Moreover, noted the House oversight chairs, the SEC and CFTC have yet to provide guidance or instruction to the marketplace on how to exactly define an ``eligible market participant’’ for entering into a swap transaction. This lack of regulatory clarity, said the Chairs, will force many financial institutions to leave the marketplace because of legal uncertainty, resulting in an increase in the cost of borrowing and the elimination of contracts used for hedging. In turn, this will create market volatility.

Another critical issue is the possible CFTC requirement to have securitization trusts register as commodity pool operators. The SEC already has substantial authority to regulate the registration and reporting of securitization trusts, noted the House Chairmen, again raising the specter of duplicate regulation. If the CFTC  designates these trusts as commodity pools, warned the leaders, the registration requirements could fundamentally alter the availability of securitization as a financing mechanism. For example, a commodity pool registration requirement would eliminate the ability of captive finance companies to use the end-user exemption for clearing and subject them to the Volcker Rule regulatory regime of Sec. 619 of Dodd-Frank. If this is allowed to occur, cautioned the House leaders, access to consumer credit will suffer.