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Cross-border swap questions haunt market as CFTC weighs next step

First Published 6th June 2013

The CFTC chairman outlined elements of what should be in the final rules for cross-border swap activity, while one commissioner called for more time to work through some thorny issues.

Gary Gensler, Chairman, CFTC

Gary Gensler, Chairman, CFTC

"Our job ... is to protect the American public."

Washington DC - The chairman of the Commodity Futures Trading Commission (CFTC) outlined four critical elements that must be contained in final guidance on cross-border swap activity, while one of the regulator's five commissioners made a plea for more time to consider the best way forward.

The CFTC has given temporary relief from the cross-border application of Dodd-Frank rules for the multi-trillion-dollar swap market, but that relief expires on July 12.

"The Commission's cross-border interpretation undoubtedly will have a significant effect on global markets and market participants," said Commissioner Scott O'Malia, who called for an extension of the relief from cross-border rules.

"Given all that is at stake, and given the looming July 12 deadline, it is imperative for the Commission to have a viable backup plan; failing to do so would be utterly irresponsible."

CFTC Chairman Gary Gensler, who has long called for rules under Dodd-Frank to cover a wide array of activities beyond US shores, listed the key elements that he said needed to be in the final guidance. Those were:

- Dodd-Frank must cover swaps between non-US dealers and guaranteed affiliates of "US persons" or between two guaranteed affiliates;

- The US person definition must include offshore hedge funds and vehicles that are majority-owned by US persons or have principal place of business in the United States;

- While foreign branches of US firms can use local rules, CFTC's guidance must ensure the definition of a foreign branch is bona fide and that the swap is actually entered into by that branch;

- Swap dealers - foreign or US - transacting with US persons within the United States are to comply with Dodd-Frank.

Gensler's stance has so far come under a fair amount of beyond-the-scenes criticism from foreign regulators, who believe the practice of "substituted compliance" should be observed whereby comparative local regulation would govern activity outside the United States.

Those criticisms have become increasingly public as top financial officials worry that swap dealers will be put in untenable positions because of differences between Dodd-Frank rules and local regulation.

But Gensler, at least in tone, suggested the CFTC needed to be firm.

"Some large financial institutions with swap businesses that dwarf those of the 2008 crisis dispute these goals because they contend it could be costly or hinder their competitiveness," Gensler said in a speech.

"But we've heard this before. It's easy for financial institutions to avoid reforms by setting up shop in an offshore locale, even if it's not much more than a tropical island P.O. Box."

He said it was rational for financial institutions to try to engineer around US regulations. "Our job, however, is to protect the American public."

O'Malia said in a statement there were a number of reasons why the Commission should not be forced into implementing a "take-it-or-leave-it" solution tied to an arbitrary deadline.

"Therefore, I am asking my fellow Commissioners to join me in releasing for public comment a proposed extension of the existing exemptive relief until December 31, 2013," O'Malia said.

He drafted a proposed extension and asked Gensler to circulate it for a vote.

He said he had significant concerns about the current draft, and doubts as to whether the CFTC can reach agreement on a final draft before the July 12 deadline.

"Even if the guidance can be finalised, there is not enough time between now and the deadline for the Commission and its fellow regulators abroad to develop a harmonised cross-border regulatory framework," O'Malia said.

At the same time, to let the relief simply expire would be, in O'Malia's view, be "unacceptable" as it would create confusion in the market. But another option, he said, would be to extend the relief.

"An extension would serve several purposes. It would allow the Commission to develop a more workable final guidance that can be adopted when it is ready, not rushed to completion due to an artificial deadline. It would allow much-needed additional time for the Commission and international regulators to continue their ongoing cooperative efforts to harmonise the global regulatory framework."

He added that it would also allow time to improve coordination on cross-border rules with the Securities and Exchange Commission.