Independence Day? Not For the Derivatives' Market
Tomorrow we celebrate Independence Day, a day when we remember our country's struggle to wrest itself from the control of laws formulated across the ocean by a government not accountable to us. How unfortunate, then, that on July 12th, the U.S. will begin imposing its rules on derivatives transactions taking place abroad. The tables have turned.
Dodd-Frank created a new regulatory framework for over-the-counter derivatives, known as swaps. The Dodd-Frank drafters weren't sure about a lot of things-what a swap is, who exactly ought to be covered by the rules, where the rules ought to apply, and how different pieces of the new statutory framework would fit together. Tough decisions like that were left to the regulators.
Under the leadership of Chairman Gary Gensler, the Commodity Futures Trading Commission, which regulates the vast majority of swaps, has made these tough decisions with little appreciation for practical reality or national borders. In a recent speech, Chairman Gensler worried that if CFTC rules don't apply internationally, "financial institutions would just skirt common-sense requirements by setting up affiliates in the Cayman Islands or some other offshore location." The CFTC wants its rules to apply not only in the Caymans, but in Europe and Japan, which do not have a reputation for being lax regulators.
Not surprisingly, the CFTC's "we can regulate everything better" attitude has been an unwelcome distraction to foreign policymakers, who are busy crafting their own swaps regulations. Michael Barnier, the European commissioner spearheading the EU's swaps rulemaking, defended those efforts late last month. He argued that "in many ways, the EU rules are stricter," including tougher standards for clearinghouses, where much of the risk of the newly remade swaps markets will end up. He underscored the importance of international cooperation grounded in the recognition that "[i]f two countries' laws address the same concerns-and offer similar regulatory oversight-then it is both logical and reasonable to mutually recognize enforcement powers."
CFTC Commissioner Mark Wetjen struck a similarly pragmatic note in a speech last week in which he called for an approach that protects U.S. taxpayers, but also "respects the limits of U.S. law and the resource constraints of U.S. and global regulators." He also called for a "clear" and "workable" approach.
Mr. Wetjen's speech offered some hope that the CFTC might devise a cross-border approach that looks something like what Mr. Barnier has in mind. Three days later, however, CFTC staff issued a letter that ought to fuel new doubts about the agency's intentions. The CFTC staff has issued a flurry of so-called "no-action" letters, which often look a lot like regulations but don't go through a formal rulemaking process. They tell industry participants what they have to do to avoid getting in trouble with the commission.
The June 28 letter dealt with a potential conflict between the CFTC's swap reporting requirements and foreign privacy laws. It allows firms dealing with foreigners covered by privacy protections not to report the foreigners' identity, provided, among other things, that the firm gets a letter by the end of August from each relevant foreign regulator-in English, of course-identifying the relevant privacy laws and their applicability to three scenarios described by commission staff. That new work assignment for foreign regulators is unlikely to help pave the way for better international cooperation.
Our friends overseas could easily adapt this portion of the Declaration of Independence to remind us that it is time for us to rein in our regulators:
We have warned them from time to time of attempts by their legislature to extend an unwarrantable jurisdiction over us. . . . We have appealed to their native justice and magnanimity, and we have conjured them by the ties of our common kindred to disavow these usurpations, which, would inevitably interrupt our connections and correspondence.
If we don't heed the warnings of our friends overseas, markets that have worked effectively to enable companies to manage their business risks will be unnecessarily disrupted.