AT TODAY’S MEETING OF THE CFTC’S GLOBAL MARKETS ADVISORY COMMITTEE, Commissioners and staff discussed cross border issues related to the application of derivatives regulation with foreign regulators. In attendance were representatives from the Japan Financial Services Agency (JFSA), European Securities and Markets Authority (ESMA), European Commission, Securities and Exchange Commission (SEC), Monetary Authority of Singapore (MAS), Securities and Futures Commission of Hong Kong, Australian Securities and Investments Commission (ASIC), and the Authorité des marchés financier in Québec, Canada. The regulators each provided an overview of their respective progress in implementing derivatives reform regulation and discussed issues related to these efforts. A complete list of regulators can be found here.
Carlene Kim, Assistant General Counsel at the CFTC, briefly reviewed the Commission’s cross border interpretative guidance, noting that some aspects of the proposal and the related proposed exemptive order are currently under consideration by the Commissioners. Of note, Kim pointed to the substituted compliance approach in the guidance and explained that the underlying comparability assessment does not entail a rule-by-rule analysis but rather a “category-by-category” approach. She also highlighted the proposed definition of “US person” by noting that the aggregation concept is based on a principle developed jointly by the SEC and CFTC, which was designed to address concerns about evasion. Finally, Kim said the final cross border guidance will reflect “careful consideration” of the comments received in response to the proposal.
Robert Cook, Director of the SEC’s Division of Trading and Markets, said the SEC is planning on releasing a proposed rulemaking outlining the Commission’s approach to applying Title VII rules extraterritorially in the “next few months.” He said Dodd-Frank-related rules that have a cross border effect will not be finalized without first taking into account the actual cross border proposal, which will include a full cost-benefit analysis. He explained that addressing the international application of Dodd-Frank rules holistically in a single release would allow market participants the opportunity to consider the proposed approach in the entire context of the regulatory scheme.
Following the staff presentations, foreign regulators discussed specific concerns related to the CFTC’s cross border proposal. Representatives from JFSA requested that the substituted compliance approach be clarified and that certain swap transactions should be excluded from the de minimis calculation with regard to the swap dealer registration determination. The officials encouraged swift action from the CFTC, noting how they are already starting to see people decline transactions with US counterparties due to the accompanying regulatory uncertainty. They also encouraged greater coordination and inspection of central counterparties (CCPs), explaining that if there is no single CCP registered or licensed in both Japan and the US then participants cannot enter into transactions without breaching the regulations of either country. They said the Japan Securities Clearing Corporation is currently seeking registration with the CFTC to become a derivatives clearing organization (DCO) but that related requirements and timelines are still not entirely clear. JFSA included a presentation that can be found here.
Officials from ESMA raised concern with the CFTC’s substituted compliance approach, noting that in the European Union (EU), third country counterparties would be subject to two or multiple sets of rules, which would raise compliance costs. The officials then explained how the EU approach is based on equivalence that relies on the robustness of supervision and enforcement by the third countries. They noted that ESMA is tasked with providing technical standards for assessing the equivalence of jurisdictions and is expected to issue such advice next year. ESMA also echoed JFSA’s concerns about conflicts arising from clearing requirements if no common CCP is used.
Patrick Pearson from the European Commission said jurisdictional rule comparisons have been conducted and that the “proposed approaches across the global simply won’t work. They won’t mesh. They won’t interact. They will cause conflicts.” He said many of the new EU rules are stricter than the US rules, arguing that a robust and comprehensive regulatory framework is already in place in the EU. Pearson raised concern with the CFTC’s cross border proposal, stating that any jurisdiction who “believes it can control every corner of risk…will fail.” To this point, Pearson endorsed a substituted compliance regime but stressed the need for effective supervisory coordination that entails an “intense” flow of information between regulators. He explained that substituted compliance should only be available if comparable high standards exist and are vigorously enforced. In addition, differences in the EU and US rules for DCOs were also raised as a potential cause of conflict.
Officials from MAS and ASIC stressed the need for more time to prepare for compliance as it relates to non-US swap dealers. The representatives said many issues are arising with regard to implementation and that more flexibility should be given for CCP and DCO registration requirements. Canadian officials echoed requests for more flexibility over implementation timing, noting that the majority of over-the-counter derivatives contracts in the country are with foreign counterparties, the majority being with US counterparties. The officials explained that this would cause Canadian market participants to come into compliance with Dodd-Frank rules very quickly, which would be disruptive. They also noted that trading mandates for electronic trading is not currently being considered but that regulators are analyzing trading data and providing themselves with the authority to implement such requirements if needed in the future.
Following the presentations, Commissioner Jill Sommers asked the regulators where they go from this point on. Officials from the European Commission said regulatory conflicts, inconsistencies and overlaps must first be identified and then options for overcoming these issues must be discussed. They noted that substituted compliance or an equivalence approach would help address many of these problems. However, the officials cautioned that gaps in regulatory regimes could lead to an accumulation of non-regulated swaps and said material problems related to jurisdictional gaps must be identified to see if a convergence on rules of substance can be accomplished.
Chairman Gary Gensler pointed to AIG and reiterated the risk affiliates pose in terms of transferring losses back to the home country. He added that the Commission is very seriously considering comments on how the de minimis threshold should be applied and said the Commission will try to narrow that provision.
Commissioner Scott O’Malia acknowledged Gensler’s concerns about risk flowing back to the US, but asked the panelists what they thought of the “direct and significant” test in the proposed interpretative guidance, adding that he would have preferred the Commission approach the entire cross border issue in a rulemaking. Specifically, O’Malia asked what the direct and significant test is when it comes to transactional rules if a product is already cleared. He also asked whether there was a comparable test in the EU.
Officials from the European Commission said the scope of the direct and significant impact on the EU has not yet been defined because that determination can only be made after other jurisdictions define that scope. They explained that the EU will want to link their approach with equivalence in that where there is equivalence there will be no need to apply the direct and significant impact test. They said the CFTC defined in the absolute what is “direct and significant,” which is problematic because it does not eliminate the potential application of more than one rule set whereas the intended EU approach would eliminate this possibility. The officials also voiced openness to modifying EU rules if an international principles-based approach can be agreed upon.
Commissioner Mark Wetjen noted that many comment letters in response to the cross border proposal reflected an “aversion” to registering with the CFTC. He asked why firms would think the proposed registration regime would be onerous if substituted compliance would also be allowed for registered entities under certain circumstances. The regulators said a fear of registration exists because the consequences of doing so are unclear in terms of what this requirement would lead to, noting how the scope of the US person definition and substituted compliance are too wide in the proposed interpretive guidance.
The second panel, consisting of GMAC members, discussed the proposed US person definition, regulation of conduits, and the substituted compliance approach. Panelists were first asked what should be a proper definition of US person. The panelists raised concern that the proposed definition in the interpretative guidance is overly expansive but noted that the temporary no-action definition helped address many concerns, but that more work needs to be done. Wetjen followed up by asking if the panelists were aware of any specific questions market participants had with respect to the temporary definition. The panelists noted that market participants were still working through the rules but said lingering concerns related to the temporary nature of the relief and the overall complexity of the regulatory regime. Wetjen responded by noting that it would be useful for him to know if aspects of the no-action relief are sufficiently clear.
Dan Roth, President and CEO of the National Futures Association (NFA), was asked about his thoughts regarding how narrow the entity definition should be. Roth said the scope of the definition directly impacts the NFA in its role as a self-regulatory organization. He explained that the NFA must first understand the scope of its responsibilities, noting, as an example, that if the entity definitions are broad then the NFA would have to know whether it is monitoring firms for compliance with CFTC rules but also for those rules for which there is substituted compliance. He questioned whether such responsibilities would then require the NFA to have expertise on the rules of foreign jurisdictions.
With regard to substituted compliance, panelists were asked how comparability should be determined. Committee members noted that the most important comparability standard relates to bankruptcy law and said differences in privacy laws must be addressed in order to achieve effective compliance with swap data reporting requirements. The panelists also reiterated concerns over the short deadlines with which market participants must comply with the new rules.
Sommers questioned whether international regulators should approach comparability standards by deciding on the most important derivatives reform principles and then tasking the International Organization of Securities Commissions with developing those principles. A number of panelists supported such an approach if more time was given to develop the principles.
For a webcast of the meeting and related materials, please click here.
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