The Commodity Futures Trading Commission passed measures July 12 that should result in greater harmonization between swap regulatory regimes worldwide, but the new rules leave uncertainties that could lead to a significant regulatory burden for end users.
Pam Brown, a senior advisor at Chatham Financial, noted that the final language has yet to be published in the Federal Register, but the “fact sheets” provided by the CFTC suggest the guidelines will be similarly challenging to those laid out in the proposal. “Despite some changes to the overall framework, complexity remains,” Ms. Brown said.
The agency’s commissioners reached an agreement on how to jointly supervise derivative traders at the eleventh hour with European regulators, who have voiced concerns about the US imposing rules stemming from the Dodd-Frank Act on market participants outside the US. The guidelines state US regulators will rely on an “outcome-based” approach to determine whether a foreign regulatory regime is comparable in terms of its objectives and therefore can be used instead of US rules.
The Securities and Exchange Commission earlier this year proposed such an outcome-based approach for securities-based swaps, and critics feared it could allow market participants to shift swap activity to where the rule regime is weakest.
For the index-based swaps it oversees, the CFTC originally proposed comparing rule regimes on a requirement-by-requirement basis to determine whether sets of rules are comparable and can be substituted. The agency appears to retain that right in the approved guidance, since after saying the CFTC will rely on the outcome-based approach, the fact sheet says the Commission’s “comparability determinations may be made on a requirement-by-requirement basis, rather than on the basis of the foreign regime of a whole.”
If the CFTC chooses that approach, then an end user may have to apply two regulatory regimes.
“We frequently deal with clients that have relationships with a variety of counterparties,” Ms. Brown said. “Depending upon who these counterparties are and whether they are eligible for substituted compliance, some of them may have to create a matrix to determine which ones trigger which requirements. This can help end-users evaluate who they should transact with based on an understanding of those requirements and factors such as pricing.”
Presumably the CFTC will apply the requirement-by-requirement approach to rule regimes whose outcomes it deems insufficiently comparable, and the rules of other major swap markets, such as the European Union’s, will be equivalent enough to be fully substituted.
The US, however, is the first jurisdiction to complete such rules, so it remains unclear just how closely other rule regimes with resemble the US’s. The CFTC commissioners decided Friday to exempt from US rules until Dec. 21 the swap dealers and major swap participants (MSPs) in Australia, Canada, the European Union, Hong Kong, Japan and Switzerland—the jurisdictions whose rules will most likely be deemed substitutable. Firms trading in other jurisdictions such as Russia and Singapore will have to start complying with Dodd-Frank rules 75 days after they are published in the Federal Register.
The deadline delay gives other jurisdictions more time to complete their swap rules and to harmonize them with the US’s sufficiently to allow then to be substituted for US rules.
“I am encouraged by [the July 12] agreement that provides global regulators with time to harmonize their derivatives regulations,” said Marie N. Hollein, CTP, president and CEO of Financial Executives International. “Non-financial customers of these [swaps] will benefit from a globally coordinated approach that provides consistent rules and protections across borders.”
Commissioner Bart Chilton noted before voting on the exemptions how interconnected global financial markets are today and so the importance of having harmonizing regulations. “That’s why the phase in of the effective dates is critical. I don’t think I could have supported this thing without it,” Mr. Chilton said.
Whether the other jurisdictions complete their rule sets by December, or they they’re sufficiently comparable to US rules to be substitutable, remains to be seen. The exemptive orders became effective July 13, and the CFTC is accepting comments on them for 30 days. Brown said it is unlikely, however, that the comments will impact the orders.
Ms. Brown said another issue likely to impact nonfinancial corporates is the dearth of specific language, at least so far, regarding cross-border, inter-affiliate swaps. She noted inter-affiliates rules approved earlier this year addressed clearing swaps among company affiliates and reporting them to swap data repositories in the US
“Without actual guidance in hand, companies will have to figure out how to treat those swaps based on what little there is in this guidance and the rules approved so far,” Ms. Brown said.