Cross-border swaps deal to end U.S.-Europe regulation overlap

July 11, 2013 05:40 PM
Accord broke a deadlock

U.S. and European Union financial regulators took a step toward bringing derivatives trading under an integrated framework of global regulation designed to reduce risks in the $633 trillion swaps market.

The accord, announced jointly yesterday in Washington and Brussels by the EU and the U.S. Commodity Futures Trading Commission, broke a deadlock over whether the U.S. could impose its rules on trades booked in Europe. Banks and other swaps traders said the deal reduces the chance they will be forced to comply with conflicting regulatory regimes.

“This shows that the CFTC recognizes that other countries and other jurisdictions have equally made a lot of progress and that they have to recognize those rules,” Ken Bentsen, president of the Securities Industry and Financial Markets Association, said in a telephone interview. “The devil’s in the details. But it would appear to be a shift in a positive way.”

The securities association represents Barclays Plc, JPMorgan Chase & Co. and Citigroup Inc. among hundreds of banks and asset managers that had raised concerns about the international reach of CFTC swap-trading requirements. European and Asian regulators had complained that the U.S. agency was overreaching by trying to extend its rules to trades that are booked overseas.

The CFTC is set to officially complete its guidance on the reach of its rules today after CFTC Chairman Gary Gensler and Mark Wetjen, a Democratic commissioner, resolved differences that had divided the commission’s three Democrats, according to four people with knowledge of their talks. The two reached agreement on the principles and were drafting a document with the details, the people said.

The CFTC yesterday issued four decisions easing some rules and deadlines in accord with the joint agreement.

Lowering Risk

“We’ve taken another significant step in our mutual journey to bring transparency and lower risk to the swaps market worldwide,” Gensler said in a statement with Michel Barnier, the EU’s financial services chief.

Failure to reach a deal could have led to “conflicts of law, inconsistencies, and legal uncertainty,” the CFTC and European Commission said in the joint statement. The agencies are “leading by example and invite other countries to join this approach.”

Under the deal, the CFTC agreed to accept some EU rulemaking as “essentially identical” to U.S. standards, allowing companies to apply only the rules of the jurisdiction where they are based. The concessions include rules on risk mitigation and how traders should settle disputes over the valuation of derivatives contracts.

Rule ‘Equivalence’

The EU has long sought a system of so-called “equivalence,” where it accepts that U.S. rules are equally rigorous as its own and allows U.S. banks to comply only with their domestic requirements. The CFTC had resisted such a reciprocal approach toward Europe.

“Many had doubts about achieving greater global financial regulatory harmonization, but this demonstrates heavy-duty headway is being made,” Bart Chilton, the third Democrat on the CFTC, said in a statement.

The CFTC also agreed to extend until the end of this year a deadline for EU-based clearinghouses to register with U.S. regulators, ensuring continued U.S. market access for EU-based clearinghouses including Deutsche Boerse AG’s Eurex Clearing and LCH.Clearnet Group Ltd., the world’s largest interest-rate clearinghouse. The original deadline was today.

AIG Lessons

Global regulators sought to bolster oversight of the swaps market after largely unregulated trades helped fuel the 2008 credit crisis and led to the rescue of American International Group Inc., a U.S.-based insurer that booked large amounts of swaps trades in Europe.

The CFTC has been putting in place new rules, required by the 2010 Dodd-Frank Act, designed to have most swaps guaranteed at clearinghouses that accept collateral from buyers and sellers to reduce risk.

For more than a year, Gensler said he was pushing for cross-border regulation to ensure that risks taken by U.S. banks and hedge funds abroad don’t wind up exposing taxpayers to risks. He said it was financial trades like those conducted by AIG that nearly toppled the economy.

“In terms of this path forward with Europe, as well as what I anticipate with our guidance, we will cover the far-flung operations of U.S. financial institutions, their affiliates, as well as the hedge funds in certain tropical islands,” Gensler said in an interview.

Impact Assessed

Banks and derivatives lawyers were working to assess the impact of the agreement with Europe and waiting for the CFTC guidance.

“While the announced framework expands opportunities for firms to mitigate duplicative regulation, I would not describe it as a framework that appropriately limits the extraterritorial application of rules to those activities involving direct and significant transfer of risk across borders,” said Edward J. Rosen, partner at Cleary Gottlieb Steen & Hamilton LLP.

While the accord settles some aspects of how swaps rules will apply across borders and averts the crisis that could have been provoked by today’s deadline, further negotiations on a range of issues will be needed.

Regulators have yet to agree on what access authorities should have to overseas-based firms’ data, “and other issues related to privacy, blocking, and secrecy laws,” the CFTC and EU commission said. Negotiations will also continue to address differing EU and U.S. requirements for the minimum collateral clearinghouses must hold to ensure they can survive market turmoil.

Negotiations Continue

“It will still take at least another year to hammer out practical answers to these issues,” Joel S. Telpner, a New York-based partner at Jones Day law firm, said in a telephone interview.

Further talks will also be needed on the conditions under which a new type of trading platform being developed by the EU, known as an Organized Trading Facility, will be allowed to offer services to U.S.-based firms.

The EU is still discussing the legislation that would underpin OTFs, which would perform a similar function to U.S. swap execution facilities. The CFTC and EU said they would review the compatibility of their respective rules in January, putting pressure on EU lawmakers to complete a deal on the bloc’s law, known as Mifid, by the end of 2013.

“Both sides aim to conclude these discussions as soon as possible,” the agencies said in the joint statement.

Mark Carney, chairman of the Financial Stability Board, has said that the FSB will report to the Group of 20 nations in September on efforts by regulators to resolve “outstanding cross-border issues” for swaps regulation, “including gaps, overlaps and inconsistencies.”

The FSB brings together regulators, central bankers and finance ministry officials from the G-20.

About the Author