December 4, 2013

ET call home | Further CFTC prevarication

Chairman Gensler recently pushed out guidance that trades booked between two non-US person entities but arranged, negotiated or executed by US personnel would be subject to CFTC regulations (as well as of course being subject to local regulations in the jurisdiction of the booking entities).

Speaking in Singapore, Commissioner O'Malia said this was beyond the CFTC regulatory brief and reverses prior guidance that the rule would be activity based – see Risk article (subs) and now says the CFTC will not likely meet its latest deadline on December 21st to finalize substituted compliance and with it the extra-territorial (ET) approach to treatment of swaps – see Reuters article.

… and today a lawsuit hit the press from three trade associations representing banks – SIFMA, ISDA and the IIB – see Reuters article.

Why so hard?

It seems the nub of this issue is an inability to come to a practical definition of "significant and direct threat to the US economy".   The concern is understandable at a high level given AIG's London CDS trading losses and JPMC's London Whale losses.  However, the approach is:

  • Impractical as one entity would be subject to two regimes simultaneously and the CFTC probably doesn't even have adequate resources to police the narrowest geographic interpretation of its remit (after all, to quote the obvious point in Morrissey's recent song: "America is not the world");
  • Runs counter to regulatory precedent which is booking-entity based for markets regulation; 
  • Is sharply contrasted with SEC's proposed OTC ET rule which already conceded that it was not the SEC's role to regulate such trades (for better or worse) which by the way would include the CDS in the AIG example.

What might work?

What's also perhaps missing is a clear division of the regulators' responsibilities to prevent tax payer impact. A natural split seems to be:

  • Markets regulators (CFTC, SEC) to regulate US on-shore booking entities to incentivize risk reduction through margin rules (cleared and bilateral) but allow substituted compliance for trades between non-US persons even where they are subsidiaries of US entities (an approach which in broad terms has already been agreed but for the exceptions like the one in discussion here)
  • Bank regulators (Fed, OCC, FDIC) to tackle cross-border exposures between US banks / SIFIs and their non-US subsidiaries via capital and liquidity regulations
  • Recovery and resolution planning regulations to minimize / prevent tax payer involvement in SIFI failures which are not prevented by market regulation, liquidity or capital buffers.

Though not perfect this might enable progress and be better than perpetual regulatory limbo.

Question: If the deadline is missed will the new Chairman take an SEC-style approach which would close the ET debate and create harmony with SEC at one stroke?


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