JPMorgan Chase & Co., Goldman Sachs Group Inc. and other banks won greater ability to fall under foreign regulations when they trade swaps overseas under guidance proposed for the Dodd-Frank Act’s international reach.
Commodity Futures Trading Commission members, in a private vote, unanimously approved proposing interpretive guidance allowing for so-called substituted compliance for branches, subsidiaries and other overseas affiliates of U.S. banks when foreign jurisdictions have comparable rules. Banks have spent two years lobbying against efforts to automatically apply Dodd-Frank to their overseas operations, saying doing so would hurt their ability to compete.
“During a default or crisis, the risk that builds up offshore inevitably comes crashing back onto U.S. shores,” CFTC Chairman Gary Gensler said yesterday in a statement. The 111-page proposal is open for public comment, which Gensler said isn’t required for guidance.
The international reach of Dodd-Frank has been among the more contentious issues affecting rules intended to reduce risk and increase transparency in the $648 trillion global swaps market. Group of 20 member nations sought tougher rules for derivatives after the collapse of Lehman Brothers Holdings Inc. and the U.S. rescue of American International Group Inc. during the 2008 credit crisis.
Gensler has said the collapse of AIG, which booked credit derivatives in Europe, and the more recent loss of at least $2 billion by London traders at JPMorgan’s chief investment office show the need to close potential loopholes in Dodd-Frank. Regulations should provide oversight of derivatives traded overseas so risk doesn’t reach U.S. taxpayers and the Federal Reserve, Gensler has said.
Swaps trading has been a major source of revenue for large U.S. banks, and some of them have conducted roughly half of such trades overseas, often through branches or subsidiaries. JPMorgan, for example, often derives as much of its quarterly revenue from global operations as from those in the U.S., Don Thompson, an associate general counsel, said on Feb. 8.
“If JPMorgan overseas operates under different rules than our foreign competitors, we can no longer provide the best products and services to our U.S. clients or our foreign clients,” JPMorgan Chief Executive Officer Jamie Dimon said at a U.S. House hearing on June 19. “The rules at the transaction level about margin reporting, all those requirements may enable Deutsche Bank to make the better deal.”
The guidance sets up two types of rules. Entity regulations govern capital, data record-keeping and internal business conduct standards, such as for chief compliance officers. Transaction regulations govern how trades are guaranteed by central clearinghouses that stand between buyers and sellers, margin, trade execution and sales practices.
Foreign swap dealers could meet entity-level rules through compliance with comparable overseas requirements, Gensler said. Overseas branches may be allowed to use substituted compliance for transaction rules when trading with clients that have a guarantee from a U.S. company or operate as conduits of U.S. entities.
Dodd-Frank transaction rules also may not apply to transactions between overseas affiliates of U.S. firms and counterparties that lack a U.S. company guarantee, Gensler said.
“If for some reason, there are not comparable laws of self-interest in nations, and there is the possibility that the lack thereof would be a potential matter of concern to the U.S., our law requires that we address it in an appropriate fashion, and we will do so,” Bart Chilton, a Democratic CFTC commissioner, said in a statement.
An initial draft of the proposal shared with commissioners on June 1 was guided by a view that the agency could have wide-ranging power overseas through what Jill E. Sommers, a Republican commissioner, dubbed an “intergalactic commerce clause” in its regulations. Revisions during the last month crafted between Gensler and others on the five-member panel have “tempered the outer limits of our initial approach,” Sommers said in a statement yesterday.
Scott O’Malia, the second Republican commissioner on the five-member panel, said in a statement that he has been assured the guidance will get another vote after the agency reviews public comments. O’Malia said he would have opposed the current version if it were subject to a final vote.
“Although the proposed guidance expressly states that the commission will exercise its regulatory authority over cross-border activities in a manner consistent with the principles of international comity, the commission’s proposed approach could be described as unilateral and dismissive of foreign law,” O’Malia said.
European Union and U.S. regulators have struggled to align the substance and timing of the measures, with banks warning that inconsistencies or overlapping rules may increase costs and give foreign competitors an advantage.
“If Dodd-Frank derivatives rules are applied to operations outside the U.S. it raises the issue of overlapping or even conflicting requirements,” David R. Sahr, a Washington-based partner at Mayer Brown LLP law firm, said in a telephone interview before the guidance was released.
The potential for wide-ranging U.S. regulators spurred opposition in Europe, Japan and elsewhere. Michel Barnier, the European Union’s commissioner for financial services, said on June 21 that U.S. regulators, including the CFTC, must “show leadership” and apply rules fairly.
“They must be prepared to rely on equivalent rules in host countries,” Barnier said in a Financial Times column. In a June 12 letter to the CFTC, representatives of Mizuho Corporate Bank, Ltd., a subsidiary of Tokyo-based Mizuho Financial Group Inc., urged respect for Japanese law.
The Securities and Exchange Commission, which has jurisdiction over parts of the credit swaps market, has said it will soon propose its own method of extending the international reach of Dodd-Frank. House Republicans have criticized the CFTC for relying on interpretive guidance that lacks an assessment of compliance costs instead of a formal rulemaking.
The CFTC unanimously approved a second document governing the timetable for compliance with the cross-border guidance. The phased-in compliance would expire for U.S. swap dealers on Jan. 1. For non-U.S. swap dealers and foreign branches of U.S. swap dealers, the timetable would expire one year after the cross-border proposal.
“The release on phased compliance also allows time for the CFTC, foreign regulators and market participants to continue to consult and coordinate on regulation of cross-border swaps activity, as well as the appropriate implementation of substituted compliance,” Gensler said in a separate statement.