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‘Perfect World’ Eludes Regulators in Aligning Swaps Rules

The potential for U.S. and foreign regulations to reach across national borders and create overlapping or conflicting rules is gaining urgency as global authorities seek to complete rules this year to prevent a repeat of the 2008 credit crisis.

The U.S. is facing increasing criticism from Canadian, British and European Union regulators over the possibility that the Volcker rule ban on proprietary trading would restrict foreign sovereign debt markets while exempting U.S. government debt. At the Commodity Futures Trading Commission, meanwhile, regulators are facing pressure from JPMorgan Chase & Co., Barclays Capital and foreign regulators to limit the international reach of Dodd-Frank Act derivatives regulations.

“There is a perfect world somewhere where there is totally consistent financial-services regulation from one end of the globe to the other, but we’re a long way from that,” Representative Jim Himes, a Connecticut Democrat and co-author of legislation defining the reach of Dodd-Frank derivatives measures, said in a telephone interview. “At the end of the day, if our regulation is more stringent, there will be a natural competitive disadvantage.”

The House Financial Services Committee held a hearing today on the international reach of the 2010 Dodd-Frank Act. JPMorgan Associate General Counsel Don Thompson told lawmakers that the rule would have a “significant disadvantage” if it affects the bank’s foreign subsidiaries without reaching overseas rivals.

“Although this varies from quarter to quarter, we often derive as much as of our revenues from our global operations as from those in the United States,” Thompson said in testimony prepared for the hearing.

No Consensus

U.S. and foreign regulators, who say they are working to coordinate rules, haven’t reached consensus and in some cases haven’t yet proposed policies to seek public comment before adopting final measures. The Volcker rule begins to take effect in July, while U.S. regulators are already more than eight months past Dodd-Frank’s deadline for new derivatives rules.

Michel Barnier, the European Union’s financial services commissioner, is planning to discuss the reach of the Volcker rule with Treasury Secretary Timothy F. Geithner when he visits the U.S. on Feb. 23, said Chantal Hughes, a spokeswoman for Barnier.

“I am concerned that the regulations could have a significant adverse impact on sovereign debt markets, including here in the U.K.,” George Osborne, Britain’s Chancellor of the Exchequer, wrote in a letter to Federal Reserve Chairman Ben S. Bernanke.

Banks’ Support

The foreign regulators’ opposition to the reach of the Volcker rule has been supported by Barclays, the Association of Banks in Singapore, Toronto-Dominion Bank and Royal Bank of Canada, among other banks that have filed comment letters with U.S. regulators.

Representatives for Mitsubishi UFJ Financial Group Inc. raised concerns about the effect of the Volcker rule on trading in Japanese government debt markets during a Jan. 23 meeting at the Fed, according to a summary of the meeting.

Regulators from the G-20, a group of the world’s richest nations and the European Union, agreed on broad principles of new derivatives regulation at a 2009 meeting in Pittsburgh. Gaps have emerged since over the substance and timing of the regulations, with differences emerging over new limits on speculation and requirements for new trading facilities.

The CFTC and Securities and Exchange Commission said in a 153-page report last week that it is “still too early to determine precisely where there is alignment internationally and where there may be gaps or inconsistencies.”

Risk, Transparency

The CFTC and SEC are aiming to complete Dodd-Frank regulations that are designed to reduce risk and boost transparency in the $708 trillion global swaps market. Both agencies haven’t proposed guidelines for the international reach of the rules.

“The London markets have good regulations. The European markets have regulations. I just don’t know that we ought to try to regulate every market from the United States,” Representative K. Michael Conaway, a Texas Republican who leads a subcommittee that oversees the CFTC, said in a telephone interview yesterday.

Representative Stephen Lynch, a Massachusetts Democrat, said an exemption for derivatives trades at U.S. banks’ foreign affiliates would create a “huge escape hatch” from Dodd-Frank.

“You’re planting the seeds for the next crisis,” Lynch said at the hearing today.

Thompson said the law includes provisions regulators can use to target potential evasions of the law. He said the ability of a bank to move from one jurisdiction to another is “wildly overstated.”

Global regulators agreed last year to set up a group to coordinate collateral requirements for derivatives that aren’t guaranteed by clearinghouses. In the U.S., the Fed, Federal Deposit Insurance Corp., CFTC and other regulators have proposed the margin requirements. In Europe, the European Securities and Markets Authority, European Banking Authority and European Insurance and Occupational Pensions Authority aim to set up similar requirements, Hughes said in an e-mail.

The global regulatory group aims to agree on a final report on the margin requirements by the end of 2012, she said.

“This report will be used by the U.S. and the EU to finalize their respective requirements and ensure a level-playing field for their respective market players,” she said.

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