US Report on International Swap Regulation Shows Gaps Among Jurisdictions | Practical Law

US Report on International Swap Regulation Shows Gaps Among Jurisdictions | Practical Law

The CFTC and the SEC released a joint report on the progress and harmonization of international swap regulation, as required by Section 719(c) of the Dodd-Frank Act.

US Report on International Swap Regulation Shows Gaps Among Jurisdictions

Practical Law Legal Update 3-517-7879 (Approx. 4 pages)

US Report on International Swap Regulation Shows Gaps Among Jurisdictions

by PLC Finance
Published on 09 Feb 2012 • USA (National/Federal)
The CFTC and the SEC released a joint report on the progress and harmonization of international swap regulation, as required by Section 719(c) of the Dodd-Frank Act.
On January 31, 2012, the CFTC and the SEC (Commissions) issued a joint report on international swap regulation, as required by Section 719(c) of the Dodd-Frank Act. The report is based on a study of swaps regulation in the US, Europe and Asia.
Though the report acknowledges that it is still too early to determine where there will ultimately be global regulatory alignment, it reveals significant differences emerging in the details and implementation schedules of swaps regulatory frameworks among these jurisdictions. Among the jurisdictions with major over-the-counter (OTC) derivatives markets, only the US and Japan have adopted recent legislation in this area, although the EU is nearing adoption of derivatives regulation.
The report's findings include, among others:
  • Clearing requirement. The scope of transactions potentially subject to mandatory clearing may differ between the US and the EU. For example, while the US Treasury has proposed an exemption from Dodd-Frank swap clearing and trading requirements for foreign exchange (FX) swaps and forwards, the European Market Infrastructure Regulation's (EMIR) proposal does not provide an explicit exemption for FX transactions. Instead, it proposes that the European Securities and Markets Authority (ESMA) would have authority to exempt FX transactions from the clearing requirement.
  • Exchange trading. Dodd-Frank requires that any swap subject to its clearing requirement must be executed on a registered exchange unless no registered exchange makes the swap available for trading. EMIR does not include an exchange trading requirement.
  • End users. Both US and EU legislation include a carve-out for end users that use OTC derivatives to hedge risk. In the EU, EMIR would establish a clearing threshold under which a non-financial entity would not be required to clear its OTC derivatives transactions. US rules would make clearing optional for these parties.
  • Segregation of client collateral at central counterparties (CCPs). The EU also appears prepared to provide greater swap collateral protection than the US. In the US, the CFTC has adopted a segregation model that provides for legal segregation with operational commingling (LSOC) for collateral related to cleared swaps. As currently proposed, the EU Council version of EMIR requires a CCP to offer customers of clearing members a choice between individual client segregation and omnibus client segregation for both listed and OTC swaps. This option is not available under final US rules.
  • Data reporting. Reporting to trade repositories (TRs) will be required for all swaps transactions under Dodd-Frank and for all derivatives transactions under EMIR, as proposed.
  • Proprietary trading. The EU does not have an equivalent to Dodd-Frank's Volcker Rule, which would limit the ability of banks to engage in proprietary derivatives trading.
Significantly, the report finds that Asia is far behind the US and EU in implementation of the unified set of swaps regulatory goals agreed to by all G-20 nations. This has the potential to create opportunities for global regulatory arbitrage among swap counterparties.
Because of this, Asian firms could attract substantial swap provider business in the intermediate term from the US and the EU. Parties outside those jurisdictions looking for swap counterparties may prefer to look for counterparties that are not subject to cumbersome swaps rules that are expensive to comply with. The expense of compliance with swaps regulation in all jurisdictions will generally be passed on to counterparties of regulated entities. For more information on regulatory arbitrage opportunities due to swaps regulation, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Regulatory Arbitrage: Swaps Regulation in Other Jurisdictions.
The first global commitments were made at the 2009 G-20, at which G-20 leaders committed to:
  • Clear all standardized derivatives through CCPs and execute them on exchanges or electronic trading platforms, where appropriate, by the end of 2012.
  • Report data on all OTC derivatives contracts to TRs.
  • Subject non-centrally cleared trades to higher capital requirements.
The G-20 leaders agreed to these OTC derivatives commitments, but the report concludes that much work remains to be done on the harmonization of global OTC derivatives regulatory reforms.
The Commissions acknowledge the benefits of working together with international regulators to harmonize global derivatives regulation. According to the report, the Commissions have consulted and coordinated with foreign regulators and support entering into memoranda of understanding to promote access to information and cooperative oversight by regulators. The report states that the Commissions are currently working on projects with:
  • The International Organization of Securities Commissions (IOSCO) to coordinate the global application of central clearing requirements for counterparties to OTC derivatives transactions.
  • The Committee on Payment and Settlement Systems (CPSS) and IOSCO on principles for financial market infrastructures, including derivatives CCPs and trade repositories.
In addition, the Commissions are participating in the Financial Stability Board (FSB) OTC Derivatives Working Group and in dialogues with regulatory counterparts in the EU, Japan, Hong Kong, Singapore and Canada. Most recently, members of the Commissions met with regulators from Canada, the EU, Hong Kong, Japan and Singapore to discuss cross-border issues related to OTC derivatives and have plans to meet again as a group in early 2012. This is noteworthy because to date there have been mixed reports on the coordination of international swaps regulation.
The report comes as US OTC derivatives regulation has been criticized as reaching beyond its authority, covering entities in other jurisdictions and raising what are referred to as "extraterritoriality" concerns. Some non-US regulators have raised concerns over "aggressive" US swaps rules that encroach on their jurisdictions. US regulators, on the other hand, would ideally like to see Dodd-Frank reach as far as possible into other jurisdictions to prevent regulatory arbitrage and flight of US swap business overseas. For more information on extraterritoriality concerns in swap regulation, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Market Trepidation over Dodd-Frank Extraterritorial Application.
The Commissions also recognize that OTC derivatives trigger many cross-border issues and they have plans to seek public comments on certain cross-border issues arising from the application of Title VII of the Dodd-Frank Act.
The report includes a global clearinghouse comparison (page 119) which sets out for each jurisdiction the following information:
  • Major clearinghouses and their regulators.
  • The clearinghouses' major contracts, clearing volumes, notional values and major clearing members.
  • A description of methods of clearing swaps.
  • A description of various systems used for establishing margin.
To learn more about swap regulation under the Dodd-Frank Act, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives.