With the United
States set to continue international
financial reform discussions with G-20 partners in September 2013, 35 members of the House of
Representatives urged the SEC and CFTC to harmonize cross-border derivatives
regulations with each other, as well as with their appropriately regulated
global counterparts. In a letter to CFTC Chair Gary Gensler and SEC Chair Mary
Jo White, the House members cautioned that the unilateral application of U.S. derivatives regulations to other countries
that are presently working on their own complementary derivatives regulatory
regimes will result in a flight of swaps activity away from U.S. banks overseas and further away from U.S. oversight. Further, while
ensuring a proper level of regulatory compliance abroad is imperative, the failure
to agree on a common regulatory framework poses risks and distortions. For one
thing, regulatory gaps would encourage regulatory arbitrage, warned the House
members, as market participants seek inappropriately regulated markets.
Other deleterious effects of inconsistent derivatives
regulation would be competitive imbalances among market participants based upon
the home jurisdiction of the participants and
inadvertent violations as market participants are forced to choose which
regulatory regime to follow. Other harmful effects would be isolating risk
inside countries or jurisdiction because of regulatory balkanization, which
could create instabilities in the risk profiles of individual countries’
markets. An overarching goal of the harmonization of regulation is to provide
for a sound and competitive international derivatives marketplace, rather than
merely just a safe U.S.
market.
The House members referenced a letter recently sent to
Treasury Secretary Jacob Lew by nine Finance Ministers and Michel Barnier, E.U.
Internal Market Commissioner, expressing concern at the lack of progress in
developing workable cross-border regulation of the OTC derivatives markets.
Left unaddressed, the failure to harmonize rules between the SEC, the CFTC, and
their global counterparts will have substantial negative effects on domestic
businesses operating abroad as well as the safety and soundness of the U.S. and
international financial systems.
More broadly, the House members pointed out that OTC
derivatives remain a crucially important financial tool for corporations,
agriculture providers, investors, and financial services firms attempting to
manage their risk. The Dodd-Frank Act enacted critical reforms to this
marketplace, formerly rife with regulatory gaps. Implementation of these
reforms, including clearing, trade reporting, higher capital levels, margin for
uncleared swaps, business conduct requirements, and periodic regulatory reviews,
will provide increased transparency and reduced risk in the OTC swaps market.
Substituted Compliance. While
the SEC has proposed regulations, the CFTC has proposed guidance, which
introduces the concept of substituted compliance under which the CFTC would
defer to comparable and comprehensive foreign regulations. 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.
E.U. concerns. In an earlier letter to the CFTC, the European Commission said that, while the doctrine of substituted compliance set forth in the proposed guidance is similar to the E.U. equivalence approach, a decision by the CFTC determining substitute compliance will not apply to jurisdictions, which is the case under the European Market Infrastructure Regulation (EMIR), but will apply only to specific firms and can be withdrawn from a firm at any time.
The Commission urged the CFTC to adopt a similar approach to that
of the E.U. based on the recognition of equivalent jurisdictions and not of
individual firms. The Commission warned that the approach taken in the proposed
guidance would introduce legal uncertainty. Also, the broad definition of U.S. person in the proposed guidance poses a
significant risk of the duplication of U.S. regulatory requirements with
those of the E.U., said the Commission.