Depending on who you talk to, a bill passed in the House of Representatives this week will either harmonize derivatives rulemaking that is inefficiently split between the Securities and Exchange Commission and Commodity Futures Trading Commission, or unravel the Dodd-Frank Act's efforts to disallow cross-border practices used to sneak trades past U.S. oversight.
H.R. 1256, the Swap Jurisdictional Certainty Act, passed in the House on Wednesday by a vote of 301 to 124. It would require the SEC and CFTC to have identical cross-border rules.
Both regulators are empowered by the Dodd-Frank Act to oversee segments of the swaps marketplace. It is widely considered that the CFTC took a stricter approach to the task at hand, particularly when it comes to cross-border trades and “substituted compliance,” the criteria for ceding authority to foreign regulators when a derivatives deal involves the foreign branch of a U.S. financial institution.
Substituted compliance is intended to alleviate the burden of equal and overlapping regulations. The CFTC's criteria is based a foreign regulator having comparable rules and regulations; the SEC approach looks less for technical parity and places its focus on the lessened burden of merely having similarly intended "regulatory outcomes."
Proponents of H.R. 1256, including sponsor Rep. Scott Garrett (R-NJ), Chairman of the Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises, tout the legislation as bringing “additional transparency and clarity” to the swaps market.
“If we get the cross-border application of Dodd-Frank wrong, the swaps trade could move permanently to foreign jurisdictions, and American end users could see the costs of the financial tools they need to compete in a global marketplace dramatically increase,” said co-sponsor Mike Conaway, a Republican from Texas. “The [legislation] will ensure that domestic and global swaps regulations are coherent and complementary.”
In April, overseas officials -- among them Michael Barnier of the European Commission, Wolfgang Schauble, Germany's finance minister, Pierre Moscovici, France's minister of finance, and Guido Mantega, Brazil's finance minister -- fretted about the potential for regulatory overreach by the U.S. in a letter to U.S. Treasury Secretary Jack Lew.
“An approach in which jurisdictions require that their own domestic regulatory rules be applied to their firms' derivatives transactions taking place in broadly equivalent regulatory regimes abroad is not sustainable,” they wrote, urging a “coherent collective solution” and said mutual recognition, substituted compliance, exemptions, “or a combination” would offer a valid approach.”
Critics see H.R. 1256 as watering down CFTC rules to conform with the less stringent requirements of the SEC. Taking to Twitter as the votes were tallied on Wednesday, Occupy Wall Street Activist Alexis Goldman tweeted: “We are watching Dodd-Frank get deconstructed before our eyes.” Opponents of the legislation point out that AIG, Bear Stearns, and Lehman Brothers Holdings, all required U.S. bailouts for failed derivatives trades that were routed through London branches.
The debate playing out this week is not a new one. At a press conference in December, members of the advocacy group Americans for Financial Reform equated cross-border exemptions to a “backdoor repeal” of derivatives reforms demanded by the Dodd-Frank Act.
Michael Greenberger, professor at the University of Maryland's Francis King Carey School of Law and former director of trading and markets for the Commodity Futures Trading Commission, argued that overseas exemptions “could sink the entire regulatory structure” for over-the-counter derivatives and swaps. Financial institutions can “by the stroke of a computer key conduct and execute swaps transactions outside the sovereign United States,” he said, adding that large U.S. financial institutions already conduct more than half of their derivatives business through foreign subsidiaries.
The vote on H.R. 1256 took place as CFTC commissioners debate what to do about a fast-approaching July 12 deadline for cross-border derivatives rules. On that date, an exemptive order for acting on drafted final guidance expires.
Commissioner Scott O'Malia, speaking at a conference in London on Wednesday, said the commission should agree to extend exceptive relief until the end of the year. “The Commission should not be forced into a take-it-or-leave-it decision tied to an arbitrary deadline,” he said.
An extension, O'Malia said,would also “allow much-needed additional time for the Commission and international regulators to continue their ongoing cooperative efforts to harmonize the global regulatory framework.”
Commissioner Bart Chilton, however, says the Commission should approve its guidance before the deadline. "We should allow for substituted compliance only when foreign rules are truly comparable in terms of substance, enforcement, and outcomes as U.S. rules,” he said, adding that the CFTC should simultaneously implement “targeted, staggered cross-border compliance.”