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CFTC's O'Malia says cross-border approach suffers from flaws

First Published 27th September 2012

The outspoken CFTC commissioner took aim again at plans for cross-border regulation, calling instead for a principle-based approach to weigh which country's rules should apply to foreign trades involving a US entity.

Scott O'Malia, Commissioner, CFTC

Scott O'Malia, Commissioner, CFTC

"What happened to the goal of establishing a level playing field as directed by the G-20 summit?"

(This version corrects the second and third paragraphs to make clear that Commissioner O'Malia found issues with the CFTC's approach to substituted compliance, not the approach favoured by many European regulators.)

Berlin - Scott O'Malia of the Commodity Futures Trading Commission (CFTC) said the regulator's proposals for cross-border regulation suffered from flaws and put US firms at a disadvantage.

O'Malia, a Commissioner at the CFTC, said there were issues with "substituted compliance," as it was proposed in the Guidance. Substituted compliance, as described in the Guidance, requires a rule-by-rule analysis, which is contrary to the traditional understanding of substituted compliance. Traditionally, substituted compliance will hold sway if local regulation is found to be equivalent.

Commissioner O'Malia called for a principle-based approach that would be consistent with the European view of substituted compliance. The principle-based approach does not require a rule-by-rule analysis, but instead generally determines whether local regulation could apply instead of US law in cases of trading activity that involved a US entity but did not take place within the US. This stance is favored by many European regulators.

O'Malia said the Commission's proposal has proven to be controversial and he was aware of comments from European and Asian regulators questioning the Commission's authority and its commitment to substituted compliance.

"I believe the proposed (CFTC) Guidance suffers from a number of flaws. One of my many concerns is that the definitions contained in the Guidance are overbroad and capture activities outside U.S.jurisdiction. These overreaching definitions put U.S. firms at a competitive disadvantage and fail to achieve the goals of global regulatory coordination," O'Malia said.

US banks have told the CFTC that European and Asian competitors abroad are already trying to entice customers away by warning them that US regulations will raise the costs of doing business with US banks, O'Malia said.

"What happened to the goal of establishing a level playing field as directed by the G-20 summit?"

At the same time, he was critical of aspects of substituted compliance.

"At first glance, allowing substituted compliance is an important step towards global regulatory harmonisation. But when you get down into the weeds, substituted compliance presents a host of issues that worry US and foreign banks."

O'Malia said there was a good chance that the Commission may determine certain aspects of the foreign regulations do in fact have a comparable regime, however, other areas of the same regulation may not meet the CFTC's standard. "Then businesses will face disparate regulatory requirements and piecemeal regulations."

Instead, he called for a principle-based approach to comparability.

In the speech, O'Malia also drew attention to a recent move by ICE to convert its over-the-counter swaps into futures and list them for trading on its Designated Contract Market.

"This may have come as a surprise to some, but not to those who trade in these markets. Given the inconsistency in the Commission's interpretation of its own rules, the lack of regulatory certainty and the increased cost of compliance with the Commission swaps regulations, including the complicated and controversial swap dealer definition rules, swap customers have turned to futures markets for regulatory certainty," he said.

O'Malia said ICE will become the first exchange to take such a step ahead of new financial regulations, but he suspected it would not be the last.

"While I certainly don't believe it was the intent of Congress or the Commission to draft rules that would drive people out of the swaps market, the regulatory uncertainty was so great that energy markets voted with their pocket-books and moved their trading business from the regulatory nightmare of swaps markets to the well-functioning futures markets."