In proposing regulations on cross-border derivatives transactions and assessing the equivalence of the U.S. and other non-E.U. regulatory regimes, the European Securities and Markets Authority must drill down past internationally agreed-upon principles to detailed regulations. Otherwise, noted ESMA Chair Steven Maijoor in recent remarks, ESMA would not tackle the potential regulatory arbitrage that can arise because many detailed differences will exist between the European Market Infrastructure Regulation (EMIR) and, for example, the Dodd-Frank Act, even when the same high level principles are met by different countries. Many of these detailed differences can be economically significant, he added, and might affect in which part of the world OTC derivatives transactions are conducted.
ESMA has not yet proposed regulations on cross-border derivatives transactions. This is because, given the international reach of EMIR, ESMA wants to take into account the on-going discussions with regulators of other jurisdictions on the cross-border application of their provisions. More specifically, said Chairman Maijoor, the reason for the postponement of the delivery of ESMA’s proposed regulations on equivalence for the U.S. and Japan is to allow sufficient time to identify, together with ESMA’s U.S. and Japanese counterparts, the appropriate solutions to avoid potential market disruptions.
In order to assess whether another country is equivalent to the E.U. derivatives regulatory regime, emphasized the Chair, ESMA must use the EMIR requirements as the yardstick. However, he noted that ESMA performs analyses that are outcome based, rather than rules based. This means that, although the starting point is the comparison of each respective set of rules, when advising the European Commission on the equivalence decision, ESMA will analyze whether different regulations can achieve a similar outcome and whether solutions can be found to prevent, on the one hand, possible market disruptions that a non-equivalent decision may bring and, on the other hand, regulatory arbitrage and risks to the European financial markets as a result of third country entities subject to less stringent requirements.
Currently, CFTC guidance on cross-border derivatives regulation is centered on the principle of substituted compliance, under which the CFTC would defer to comparable and comprehensive foreign regulation. The CFTC proposes to permit a non-U.S. swap dealer or non-U.S. major swap participant, once registered with the Commission, to comply with a substituted compliance regime under certain circumstances. Substituted compliance means that a non-U.S. swap dealer or non-U.S. major swap participant is permitted to conduct business by complying with its home regulations, without additional requirements under the Commodity Exchange Act.
The SEC has indicated that it will do a formal rulemaking with an attendant full cost-benefit analysis on cross-border derivatives transactions. Given the global nature of the derivatives market, said former Director of Trading and Markets Robert Cook, the SEC will take a holistic approach on cross-border regulations.
Congress is watching these developments very carefully. Last year, a House panel pressed CFTC Chair Gary Gensler and SEC Director Cook on the harmonization of regulations implementing the derivatives provisions of the Dodd-Frank Act both domestically and globally. Members of the House Capital Markets Subcommittee expressed concern that, with regard to cross-border derivatives transactions, the CFTC issued guidance centered on the doctrine of substituted compliance, while the SEC will conduct formal rulemaking.
At the hearing, Rep. Spencer Bachus (R-AL), then Chair of the full Financial Services Committee, now Chairman Emeritus, said that market participants have grave concerns about substituted compliance and foreign regulators do not seem to agree with substituted compliance. He queried if any foreign regulators have endorsed the CFTC’s approach. Chairman Gensler responded that market participants requested substitute compliance and the Commission embraced what the market participants wanted. Further, he noted that the CFTC engaged in extensive consultation with international regulators and continues to work with them on cross-border issues.
Director Cook testified that the Dodd-Frank Act specifically requires the SEC and CFTC to consult and coordinate with foreign regulators on the establishment of consistent international standards with respect to the regulation of OTC derivatives. Thus, the SEC is actively working on a bilateral and multilateral basis with its global regulatory counterparts to address the regulation of OTC derivatives.