Escaping cross-border regulatory requirements with an insurance fund

For some reason, the Wall Street Journal posted its lead editorial on May 28 to criticize Commodity Futures Trading Commission Chairman Gary Gensler for supporting new CFTC "guidance" on who, abroad, must comply with the Dodd-Frank Act and related CFTC regulations. In brief, the editorial said that the CFTC should be more deferential to market regulators in foreign lands and not impose U.S. standards across the border or the pond.

Let's set aside the fact that Dodd-Frank (aka Congress) clearly directed the CFTC to expand its reach into other countries when activity there does damage in the U.S. And let's agree that most leading foreign markets have some level of local regulation that works reasonably well. But let's also concede that problems in the United Kingdom or Japan or Australia can, and sometimes do, harm U.S. interests. So, what to do?

This is a tough question. The CFTC is prepared to defer to foreign regulatory regimes for offshore business transactions where they are "comparable" to the U.S. requirements and are enforced with "comparable" vigor. Of course, the quoted word is ambiguous and fluid, leaving plenty of wiggle room. But the concept is not new; the CFTC used it aplenty during the pre-Dodd-Frank era in deciding what foreign futures markets serving U.S. traders could avoid having to be licensed here.

The Dodd-Frank approach is all about preventing cross-border financial crises through the enforcement of high standards. No crises, no problems. But it is not the only possible solution.

As an alternative, suppose that each jurisdiction wishing to escape the clammy paws of Dodd-Frank had a substantial "crisis fund" to reimburse innocent counterparties after a major financial default originating there? Somewhat like the Securities Investor Protection Corporation that covers (within limits) securities customers when their broker fails? The new program would apply to defaults on contractual obligations involving futures contracts, options and swaps when an U.S. counterparty is the victim. A foreign country could fund it through assessments on local market professionals, perhaps with a government overlay.

There is no provision in Dodd-Frank for such a mechanism, so action by the Congress may be needed (during one of those rare moments when it is neither adjourned or deadlocked). But it would allow another sovereign (and its constituents) to escape U.S. rules if they wish, or to tolerate CFTC incursions if not. The problem of cross-border catastrophes could be addressed without regulatory invasions. That should make even the Journal happy.

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