On July 6, House Financial Services Committee Chairman Spencer Bachus (R-AL) initiated a series of
hearings reviewing the two-year experience of the Dodd-Frank Act, and in particular the effects of its derivatives provisions. Prompted by the June 28 release by the CFTC of
proposed interpretive guidance regarding the application of the Dodd-Frank Act to non-US persons engaging in swaps activities with a connection to the US, Bachus also urged the Senate to pass legislation, HR 2682, codifying and clarifying the end-user exemption from Dodd-Frank derivatives regulation. These congressional moves arise amid fears in the financial industry that the CFTC's proposed cross-border rules could create dangerous fragmentation among financial firms operating internationally.
The Dodd-Frank Act amended the Commodity Exchange Act to exclude activities outside of the United States from swaps regulation unless those activities “have a direct and significant connection with activities in, or effect on, commerce of the United States” or unless regulation of those activities is “necessary or appropriate to prevent evasion” of compliance with any provision of the Dodd-Frank Act. The CFTC's June 28 release sets forth CFTC’s interpretation of its extra-territorial authority to regulate swaps and swaps dealers under the Dodd-Frank Act. Swaps dealers and other major financial industry players worry that the extraterritorial application of these US regulations could create two sets of rules for swap regulation, and could isolate the US swap market from the global market. They fear that non-US entities will avoid transacting with US financial intermediaries or end users if doing so subjects them to US regulation globally. This could deny US firms access to the global derivatives markets, and dramatically increase the cost of hedging, potentially keeping them from hedging at all.
Though the CFTC's guidance clearly contemplates "substituted compliance," meaning that non-U.S. swap dealers or non-U.S. major swap participants would be permitted to conduct business by complying with their home regulations, those in the industry feel that, given the complexity of the US regulations, substituted compliance will not work in practice. If subjected to US regulations globally, international financial firms could potentially be faced with layers of overlapping and perhaps contradictory or inconsistent regulations.
For a non-US financial firm, registering in the various jurisdictions in which it conducts business may be the only practical way to comply with the network of derivatives regulations. This fragmentation of its business could eliminate all the benefits derived from firm-wide risk management programs, collateral management, and netting, making the global derivatives market less rather than more secure.