Fight over reach of U.S. derivatives rules heads for showdown

CFTC will vote on the guidelines July 12

A three-year battle over the international reach of U.S. rules is coming to a head this week as regulators attempt to complete final guidelines for their oversight of overseas derivatives trades by JPMorgan Chase & Co., Goldman Sachs Group Inc. and other banks.

The Commodity Futures Trading Commission called a July 12 meeting to vote on the guidelines, even as commissioners are at odds over how far to expand the regulator’s overseas reach. The proposed guidelines have also created a rift with foreign regulators, who say their rules are sufficient for regulating derivatives trades in their jurisdictions.

The U.S. agency is debating phasing in the guidance through the end of the year, according to two people with knowledge of the deliberations.

“Having told us to get our act together -- which we are now clearly doing -- is the U.S. suggesting that they cannot trust our systems and that only their rules can apply?” Nadia Calvino, the European Commission’s deputy-director general for internal market and services, said in a speech last week in Brussels.

The international reach of Dodd-Frank Act regulations has been one of the most controversial parts of the effort to reduce risk and increase transparency in the $633 trillion swaps market. Regulators around the world decided to increase oversight of the market after largely unregulated swaps helped fuel the 2008 credit crisis and led to the collapse of American International Group Inc.

Divided Oversight

The New York-based insurer booked many of its swaps in Europe. Regulators there and in the U.S. had a split arrangement for overseeing the company that “excluded any comprehensive examination and regulation” of AIG’s credit-default swaps, the Congressional Oversight Panel said in a 2010 report.

The CFTC’s proposed guidance was criticized by JPMorgan and other U.S. banks for threatening to put them at a competitive disadvantage when they trade overseas.

Swaps trading has been a major source of revenue for large U.S. banks, and some have conducted roughly half of such trades overseas, often through branches or subsidiaries. JPMorgan, the nation’s biggest bank by assets, often derives as much of its quarterly revenue from global operations as from those in the U.S., Associate General Counsel Don Thompson said last year.

CFTC Chairman Gary Gensler has pushed for a broad reach of Dodd-Frank rules because of the potential for trades overseas to flow back to institutions in the U.S. and possibly put taxpayers at risk.

SEC Discussion

Treasury Secretary Jacob J. Lew held a meeting last week with Gensler and Securities and Exchange Commission Chairman Mary Jo White, whose agency is also working on derivatives rules, to improve discussions about the cross-border issue, according to a person familiar with the meeting who requested anonymity because it was private. Gensler and the CFTC were urged to share more information about its process, the person said.

A temporary exemptive order that the agency completed last year expires on July 12, prompting the agency’s four commissioners, particularly Gensler and Democrat Mark Wetjen, into a last-minute negotiating session. Jill E. Sommers stepped down yesterday as a Republican commissioner, leaving an open spot on the five-member panel.

“This thing needs to be resolved one way or another by the 12th,” Bart Chilton, one of three Democrats, said yesterday. “If we can reach a resolution prior to the meeting, great. If we can’t, let’s meet and hammer it out there.”

Three Documents

Commissioners are discussing three documents: final guidance for how Dodd-Frank rules ought to be applied, a phase- in process and a separate letter on some transaction and recordkeeping rules providing that European requirements are essentially identical, according to a one of the people with knowledge of the process. Gensler and CFTC employees have been in negotiations with European regulators on the letter, the person said.

One of the biggest debates is when the CFTC will allow companies to comply with overseas rules to substitute their compliance with Dodd-Frank. Commissioners are negotiating when and how that process will be applied and whether firms located in the U.S. might be eligible for substituted compliance when they are on one side of a trade with non-U.S. counter-parties.

“People are perpetuating this lie that if we don’t extend our reach to U.S. entities operating elsewhere they won’t be regulated,” Sommers said in a telephone interview. “It is in fact moral hazard for the CFTC to claim we have the resources to do this. We should want the help of global regulators,” Sommers said. “That’s unfortunately not the view of the chairman.”

The EU has said that a solution to the dispute lies in a so-called equivalence, or substituted compliance system, in which U.S. regulators would accept that EU rules are equally robust as U.S. standards, and so avoid where possible imposing additional requirements on EU-based banks.

Equivalance, and substituted compliance are “the only way forward to protect financial stability, while allowing the financial sector to allocate capital efficiently throughout the world,” Calvino said.

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