The Commodity Futures Trading Commission (CFTC) may have tempered its ambition to regulate cross-border swaps, but whistleblowers abroad still will play an important role in preventing regulatory evasion.
In June 2012, the CFTC proposed sweeping regulation of swaps that cross U.S. borders. The proposal would have regulated all U.S.-facing swaps, and more than a few foreign firms would be subject to entity-level requirements. However, pushback from the industry and foreign regulators caused the CFTC to reassess.
The agency then offered a diluted proposal and took public comments, but the CFTC has yet to revisit the issue. Instead, in early December the CFTC issued a joint statement on global swap regulation with other G-20 regulators. The statement announced a consensus-based approach to cross-borders regulation.
The CFTC’s authority and commitment to prosecute those who evade regulation appear unwavering and unquestioned — even when the evasion comes abroad.
We can expect such regulation to be like the IRS’ enforcement focus on offshore financial centers. Regulatory arbitrage causes violators to engage in numerous complex schemes to park funds in favorable jurisdictions to evade U.S. tax liability.
Similarly, jurisdictions with lax oversight could draw firms seeking to avoid swap regulation. For example, firms may organize foreign subsidiaries, as opposed to branches, to avoid entity-level capitalization and management requirements.
For the time being, substantive cross-border regulation seems to have stalled.
To be sure, the CFTC may insist that individual swaps involving U.S. citizens meet new requirements, like mandatory clearing. Some entity-level requirements, like reporting, also may survive. This is because the CFTC has expressed the view that these requirements further critical oversight objectives.
But three things signal that the agency will adopt a position that is much more modest than the June 2012 proposal.
First, in addition to the diluted July proposal that the CFTC eventually offered, the CFTC’s joint statement with G-20 regulators signals that the CFTC is now committed to a consensus-based approach that will guarantee a retreat from the CFTC’s original, internationally unpopular proposal. Second, the agency has declined to issue final guidance despite closing the public comment period four months ago. The agency said it plans to issue the guidance, but it has declined to do so in several final rules that the agency has issued since the comment period. Finally, the long-awaited final rule on mandatory swap clearance made substantial concessions to the industry, signaling that the agency may do so again in the cross-border context.
Even if the CFTC takes an aggressive position on cross-border regulation, only the very largest foreign firms will be covered. This is because the mandatory swap clearance regulation exempts any participant whose annual swaps have a notional value of less than $8 billion (a threshold that will drop to $3 billion after a phase-in period) from the definition of “swap dealer” and “major swap participant.” As such, only the largest firms will incur extensive regulation as swap dealers or major participants.