Tuesday, May 17, 2011

NY Senators Caution that Dodd-Frank Derivatives Regulations Must Be Harmonized Globally to Avoid Regulatory Arbitrage

Senators Charles Schumer (D-NY) and Kirsten Gillibrand (D-NY) have warned that proposed margin regulations on derivatives between non-U.S. subsidiaries of U.S. entities and non-U.S. counterparties are not harmonized internationally as Dodd-Frank intended and could presage a ``race to the bottom’’ harmful to the competitiveness of US financial institutions. In a letter to CFTC Chair Gary Gensler and banking regulators, the Senators asked the Commission to reconsider the extraterritorial application of these requirements in a way that is consistent with Congressional intent regarding the territorial scope of the new Dodd-Frank regulatory framework for derivatives. Ideally, said the Senators, international derivatives regulations should perfectly mirror U.S. regulations adopted under Title VII of Dodd-Frank in order to minimize the opportunity for regulatory arbitrage by non-U.S. customers of U.S. entities. The letter was also signed by a bi-partisan NY House delegation.

Harmonizing US derivatives regulations globally is important, said the Senators, since the disparate treatment of U.S. firms will encourage participants in the derivatives markets to do business with non-U.S. firms. It is thus imperative to strike a balance between implementing the new safeguards and harming the competitiveness of U.S. financial institutions vis-à-vis their international counterparts.

Cognizant of the need to strike this balance, Congress included provisions in Dodd-Frank expressly instructing federal regulators to guard against evasion of the law as well to impose the regulations extraterritorially beyond the U.S. only if there is a direct and significant connection with U.S. activities or commerce. According to the NY Senators, these provisions are intended to protect both the safety of the financial system, by preventing regulatory arbitrage for the purpose of evading the law and the competitiveness of U.S. financial institutions.

They are concerned that proposed regulations implementing Title VII would disrupt that balance and could have significant negative effects on the competitiveness of U.S. institutions. Under the proposals, margin requirements do not apply to non-U.S. banks doing business with non-US clients, but they do apply to non-U.S. subsidiaries and affiliates of U.S. institutions doing business with non-US clients outside the U.S. This disparity in treatment creates a severe disincentive for non-U.S. companies to do business with overseas affiliates or subsidiaries of U.S. financial institutions.

The application of new margin requirements to activity taking place wholly outside the U.S. must be coordinated with international regulators. The Senators urged the CFTC and the banking agencies to work closely with their international counterparts to ensure that they adopt as rigorous a regulatory regime for the over-the-counter swaps markets in their countries as the US will under Dodd-Frank.