The Commodity Futures Trading Commission on Thursday voted 3-2 to approve a rule under the Dodd-Frank Act that cedes the CFTC’s regulation of non-U.S. market participants in cross-border derivatives to other countries. The rule will exempt swap dealers (SD) and major swap participants (MSP) already registered with foreign regulators from also having to register with the CFTC under provisions of the Commodity Exchange Act (CEA).
Supporters said the move is an acknowledgement of the vitality of foreign regulation of those activities. Critics like Better Markets, a non-profit that favors tougher regulation of American financial markets, alleged the CFTC was “recklessly outsourcing the protection of American taxpayers to foreign regulators.”
The CFTC also approved an amendment to the rule that exempted 16 multilateral trading facilities (MTFs) and organized trading facilities (OTFs) already registered with the European Union from having to register as swap execution facilities in the United States. The amendment went into effect immediately; the new rule will go into effect 60 days after being published in the Federal Register.
Chairman Heath Tarbert joined with Commissioners Brian Quintenz and Dawn Stump to support the move, while Commissioners Rostin Behnam and Dan Berkovitz voted no. The vote fell along party lines, with the two Democratic commissioners opposed.
“Because nearly all G20 jurisdictions have adopted similar swaps regulations pursuant to the Pittsburgh Accords, it is unnecessary for the CFTC to be the world’s policeman for all swaps,” wrote Tarbert in his supporting statement.
“The CFTC should not be incentivizing U.S. banks to use U.S.-located personnel and booking fictions to trade, clear, and ultimately hold derivatives risks in U.S. banks and other financial institutions, while evading the requirements Congress placed on those activities in light of their potential for mass destruction.”
Dennis M. Kelleher, President and CEO, Better Markets
In his dissenting statement, Berkovitz said of the move: “The structure of the Final Rule practically invites multinational U.S. banks and hedge funds to book their swaps in offshore affiliates to avoid our swap dealer regulations. This will permit risks to flow back into the United States with none of the intended regulatory protections.”
Reaction among those watching the markets was mixed as well.
Akshay Belani, a partner in the New York law firm Stroock, called the move “a welcome change” that would “ease regulatory burden for the market,” but noted that ceding U.S. authority to regulate the market to foreign governments also “does carry the risk that its foreign counterparts will not be as effective at monitoring and mitigating systemic risk.”
Better Markets charged that foreign countries have “regularly failed” to uphold strong regulations.
“The CFTC should not be incentivizing U.S. banks to use U.S.-located personnel and booking fictions to trade, clear, and ultimately hold derivatives risks in U.S. banks and other financial institutions, while evading the requirements Congress placed on those activities in light of their potential for mass destruction,” Better Markets President and CEO Dennis Kelleher wrote in a statement.
Rule approved on capital requirements for swap dealers
On Wednesday, the board voted by the same 3-2 margin to approve new capital and financial reporting requirements for SDs and MSPs, also part of Dodd-Frank.
The new rule imposes new capital requirements on SDs and MSPs that are not subject to supervision by a banking regulator. It also imposes financial reporting requirements for SDs and MSPs generally.
SDs can elect one of three alternatives to establish and meet minimum capital asset requirements: a net liquid assets method, which is based on capital asset requirements for Securities and Exchange-regulated entities; a bank-based method for entities regulated by the Federal Reserve Board; and a tangible net worth method, which would apply to SDs part of a larger commercial enterprise.
“The final capital rule is designed to enhance customer protection and reduce systemic risk in the financial system,” wrote Tarbert in a statement. “Capital requirements are the ultimate backstop, ensuring that customers are protected and the financial system remains sound in the event that all other measures fail.”
The rule sets the amount of capital that a futures commission merchant swap dealer must maintain at equal to or greater than 2 percent of the initial margin “associated with the SD’s proprietary cleared and uncleared futures, foreign futures, swap, and security-based swap positions.”
The final rule also makes several amendments to existing capital requirements for futures commission merchants to impose specific requirements for swaps and security-based swaps.
In his dissenting opinion, Berkovitz said the rule “is not based on quantitative analysis of data or the appropriate level of capital for the risks presented by a swap dealer.”
“Rather, it appears to be designed with the objective of ensuring that most dealers will not need to raise more capital,” he said, concluding that the regulation “is simply an affirmation of the status quo.”
Behnam noted that a previous proposal of the rule set the margin at 8 percent, which market participants claimed was too high.
“I am not sure if 2 percent is the appropriate landing spot to insulate our markets from outsize risk. And based on the preamble to this Final Capital Rule, I do not think the Commission is certain either,” Behnam wrote in his dissenting opinion. He urged the Commission to study the issue further.
The capitalization rules are effective 60 days after publication in the Federal Register. Market participants must be compliant by Oct. 6, 2021.