Thursday, September 25, 2014

Commissioner Giancarlo Criticizes CFTC Cross-Border Guidance, Calls for “Reset”

[This story previously appeared in Securities Regulation Daily.]

By Lene Powell, J.D.

CFTC guidance on the cross-border application of Dodd-Frank swaps regulation has fragmented global swaps markets and risks a trade war over swaps market clearing and execution, said CFTC Commissioner J. Christopher Giancarlo.

“I am here today to call for a reset in the EU and CFTC cross-border regulatory relationship in the spirit of the Pittsburgh G-20 accord. I call for this reset to avoid a trade war in financial markets akin to that which worsened the Great Depression,” said the commissioner in remarks prepared for delivery to the Burgenstock Conference in Switzerland.

Recently, the CFTC largely beat a court challenge to its cross-border guidance by industry groups, though the court warned the CFTC to be ready to defend the guidance if the agency ever uses it in an enforcement action or other lawsuit.

Market fragmentation. According to Giancarlo, the CFTC started a rift in cross-Atlantic swaps regulation when it issued an Interpretative Guidance in July 2013 that asserted that all swaps entered into by a US person, no matter where transacted, had a “direct and significant” connection with US commerce requiring the imposition of CFTC transaction rules. The CFTC followed the guidance with an Advisory in November 2013 that said that CFTC trading rules apply if a trade is “arranged, negotiated, or executed” by personnel or agents of a non-US swap dealer located in the US, even if no US person is party to the trade.

The combined effect is that CFTC has dictated that non-US market operators and participants must abide by the CFTC’s “peculiar, one-size-fits-all” swaps transaction-level rules for trades involving US persons or supported by US based personnel, said the commissioner. In conjunction with lack of coordination between the US and EU on recognition of clearinghouses, this has fragmented global swaps markets into regional ones, by Balkanizing pools of trading liquidity and market pricing.

Risk of trade war. Likening the CFTC’s cross-border rules to the Smoot-Hawley Tariff Act of 1930, which sharply increased tariff rates on many imported agricultural and manufactured goods and touched off retaliation from trade partners, Giancarlo said the CFTC’s interpretative guidance in July 2013 was “wreaking havoc” and forcing US financial institutions to retreat from what were once global markets.

A trade war would be disastrous for the US and EU, said Giancarlo. The US must retain deep and liquid capital markets to maintain its reserve currency status and its standard of living. Fragmentation causes smaller and disconnected liquidity pools and less efficient and more volatile pricing for market participants and end-user customers, as well as greater risk of market failure in the event of economic crisis. For its part, the EU desperately needs investment in economic development and job creation. European investment capital comes overwhelmingly from banks, which are significant participants in the US derivatives markets. EU banks cannot afford to retreat from those markets, he said.

Call for cooperation. The US and EU must reach an accord on how to regulate derivatives execution and clearing in a harmonious manner across jurisdictions. “Flourishing capital markets are the answer to US and European 21st century economic woes, not trade wars and protectionism,” said the commissioner.

Giancarlo praised a recent decision to seek comment on three different approaches to the cross-border application of CFTC rules for margin for uncleared swaps, commending it as a portent of greater accord in global regulatory reform. He said he will encourage the CFTC to replace the guidance with a formal rulemaking that recognizes outcomes-based substituted compliance for competent non-US regulatory regimes. The best route to swaps regulation involves deference to home country regulators within the Pittsburgh G-20 framework, and Giancarlo hopes the staffs of the CFTC, European Commission (EC), and European Securities and Markets Authority (ESMA) will redouble their efforts to craft a workable basis for the EC to issue its equivalence determination for the US.

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