Global markets need more rapid cross-border harmonization in order to prevent them from splitting. So observed CFTC Commissioner Scott O’Malia in a recent speech. Mr. O’Malia comes to this conclusion following a report that US and European swap markets are fragmenting, leaving US end-users seeking hedges with shallower pools of liquidity in some currencies.
“Unless the Commission and foreign regulators undertake serious efforts to recognize each other’s regulatory regimes on data, clearing, and execution based on a flexible, outcomes-based approach, we risk developing micro-solutions that highlight our differences rather than our commonality,” said Mr. O’Malia at a May 6 conference sponsored by the Tabb Group.
Mr. O’Malia noted that last December the commission made “extremely narrow substituted compliance determinations,” and that it has not made any additional determinations since then. He added that’s having the “tangible and negative effect of fragmenting liquidity in the swaps market.”
He referred to a recent article in Risk.net that found US swap users are being shunned by foreign counterparties that want to avoid Dodd-Frank Act requirements. US regulators have interpreted the law as extending those requirements to foreign entities dealing directly with “US persons,” which include corporations incorporated in one of the US states. Substitutive compliance determinations allow those foreign entities to follow the rules of the jurisdiction where they are incorporated and avoid duplicative reporting, and vice versa for US swap users.
Mr. O’Malia noted that he had advocated a more expansive effort to recognize efforts by international regulators and a more flexible “outcomes-based approach” to the process. Instead, the commission approved select determinations at the entity and transaction level that give end users relief in some areas but require duplicative efforts in others.
European Union reporting rules became effective three months ago, Mr. O’Malia said, and yet there is still no international data sharing agreement between the US and EU, and no mutual recognition of swap data repositories and EU trade repositories. The agreements are crucial so regulators can compare and aggregate data in order to monitor and analyze risks in the global financial system, he said, adding that it is also important so that market participants are not burdened by duplicative reporting requirements.
“I call on the commission and the EU to sign an international data sharing agreement, collaborate to harmonize both the form and format of data being reported, and recognize each other’s swap trade repositories. We must get back to the substituted compliance process and follow a flexible, outcomes-based approach,” Mr. O’Malia said.
Along similar lines, Mr. O’Malia said the conditional relief given CFTC staff to relieve Europe’s multilateral trading facilities (MTFs) from having to register as US swap execution facilities (SEFs) still requires them to “basically” look like a SEF and comply with the CFTC’s reporting and clearing requirements. In addition, the staff can pull that relief of the MTF’s business leans to heavily toward US business.
As a result, said Mr. O’Malia, pointing to the Risk.net article, non-US swap counterparties are refusing to trade with US persons, and instead insisting on trading with US banks’ non-guaranteed affiliates to avoid the Commission’s regulations.
“This means [US swap users] cannot directly access non-US pools of liquidity and must instead trade through the banks,” he said.