Sunday, October 14, 2012

Global Derivatives Reforms. Getting it Right the First Time.

[G]lobal interconnections within the swap markets require cross-border regulatory cooperation and harmonization, as no one national regulator is equipped with the resources necessary to regulate comprehensively every participant in its local market nor every market in which its local institutions participate. At the same time, these global interconnections increase the potential for conflicting national implementation of regulatory reform to have adverse effects on the markets and market participants, especially if applied extraterritorially.
              -- August 27, 2012 Letter from the IIB to the CFTC

Concern mounts among regulators, legislators, and industry players about the international effects of regulating OTC derivatives. Principally, they are worried about the lack of coordination among the CFTC, SEC, and their global counterparts, and the effect conflicting rules may have on the derivatives markets and the activities of firms with international operations.  As the deadlines loom for Dodd-Frank and Volker Rule implementation, influential voices are raising the alarm about potential harm to the US economy and investors, and making the case for a more coordinated and thoughtful regulatory effort with regard to OTC derivatives.

On August 27, 2012, the Institute of International Bankers penned a letter to the CFTC highly critical of its recent rule proposal designed to implement cross-border application of its new swaps regime.  While generally supportive of the regulatory effort, the IIB is concerned that certain aspects of the CFTC’s proposal would likely give rise to conflicts with foreign rules and, in so doing, impede cross-border market participation and regulatory coordination.  The IIB believes that the exemptions for extraterritorial activities are imprecise and too narrow. The group cautions that inappropriately imposing the proposed US OTC restrictions to activities outside the US would result in a host of unintended adverse consequences for international banks, and put the US economy and US investors at a disadvantage globally.  They argue that the rules as proposed would restrict the flow of capital from foreign investors to US companies, reduce the liquidity in US markets, while not providing any benefit to the soundness of US banks.  In their letter, IIB says that in order to limit the negative effects of the proposed rules, they should be amended to exclude transactions by international banks that do not put US financial stability, the safety and soundness of US banks or US taxpayer dollars at risk.

Similarly, in an October 5, 2012 letter to Treasury Secretary Timothy Geithner, the chairs of four House oversight committees requested that Geithner use his authority as the chair of  the Financial Stability Oversight Council (FSOC) to delay the CFTC's implementation of the new swaps regulatory regime over concerns about its effects internationally.  The letter signed by Agriculture Committee Chair Frank Lucas (R-OK), Commodities and Risk Management Subcommittee Chair K. Michael Conaway (R-TX), Financial Services Committee Chair Spencer Bachus (R-AL), and Capital Markets Subcommittee Chair Scott Garrett (R-NJ) is critical not just of the lack of coordination internationally, but of the lack of coordination between the CFTC and SEC.

We must avoid the illogical creation of a disparate regulatory environment that would result in the same market participant being deemed a "US person" for trading swaps while simultaneously considering them a "non-US person" for trading security-based swaps.  Without global coordination, US market participants will be permanently disadvantaged if their business is siphoned away by foreign competitors, which could significantly impair our markets for the foreseeable future. 
The legislators argue that it is more important to avoid market confusion and economic harm than it is to meet arbitrary regulatory deadlines.

Worried about international coordination of regulation of margin requirements for non-centrally cleared derivatives, SIFMA took its concerns to the Working Group on Margining Requirements of the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO).  In their September 28, 2012 comment letter, SIFMA iterated that it is vital that the new margining requirements be coordinated globally, and the new regulations be balanced against their inevitable effects on market liquidity.

Margin requirements for non-centrally-cleared derivatives are a key component of the overall reform program initiated by the Group of Twenty (“G-20”) in 2009. These requirements will potentially have a significant impact on users of non-centrally-cleared derivatives and derivatives market intermediaries and, as a result, the real economy. These impacts will be felt both in times of market stability and, likely with even greater effect, in times of market stress. Our members believe it is critical that international supervisors adopt margin requirements that are consistent and effectively balance financial stability with liquidity and cost trade-offs.
It remains to be seen how this chorus of voices for more thoughtful and coordinated regulation of OTC derivatives will influence policy makers and regulators.  With fragile economies, including the US, working their ways back to recovery, regulatory missteps on the OTC derivatives front could be costly. Though there is some disagreement about how it can be done, the consensus is that it is better to get it right the first time.