Wall Street May Take Derivatives Regulator to Court
Wall Street banks reeling from a flurry of activity by departing U.S. Commodity Futures Trading Commission Chairman Gary Gensler are considering taking the agency to court.
Gensler has issued more than a dozen advisory opinions directed at reining in the largest financial firms and swap traders without votes by his fellow commissioners. He’s also insisting on tightening the Volcker rule ban on proprietary trading by banks, making last-minute demands that could derail a regulation that must be approved by five U.S. agencies.
The financial industry’s trade groups have consulted with lawyers about how to block Gensler’s final moves, according to four people briefed on the matter. A lawsuit would probably be focused on CFTC guidance issued in July that described when the agency should defer its rules in favor of regulations by foreign derivatives overseers, the people said.
Gensler, 56, has fought a five-year battle with the industry over how to draw up a safer and more open marketplace for derivatives, the products that helped push the world economy to the precipice in 2008. He is trying to cement his legacy, said Fred Hatfield, a former Democratic CFTC commissioner.
Gensler is “trying to do an awful lot in a very short amount of time,” said Hatfield, who now works at Patomak Global Partners LLC, a regulatory consulting firm in Washington. “He’s leaving as little to chance as could be possible.”
President Barack Obama has nominated Timothy Massad, 57, a Treasury Department official, to succeed Gensler, whose term has expired and who must leave by the end of the year.
The activity in recent weeks has set up the equivalent of a high-stakes chess match between Gensler and the financial industry, which was holding off negotiating on some rules until he left, according to two people involved in the discussions. They and the others interviewed for this story spoke on condition of anonymity because their meetings were private.
The agencies that must sign off on Volcker also have been dealing with Gensler’s last-minute bargaining tactics. All five regulatory agencies don’t have to issue the rule simultaneously, and it is possible that some could press ahead with the rule without waiting for the CFTC to act.
A former Goldman Sachs Group Inc. partner, Gensler is well-schooled in the ways of Wall Street and has emerged as one of its main adversaries in Washington. In implementing the derivatives rules mandated by the 2010 Dodd-Frank Act, he often takes an issue to the brink before striking a deal that is more amenable to the industry than what he first proposed.
This time, the banks have decided they have little recourse except to sue the agency for not following the proper procedures for issuing regulations, said the people briefed. The Securities Industry and Financial Markets Association, Wall Street’s main lobbying group, recently set up a conference call that included the firms’ general counsels and attorney Eugene Scalia, a Washington lawyer who has filed several cases seeking to overturn Dodd-Frank rules.
The International Swaps and Derivatives Association, another Wall Street-dominated trade group, has also consulted with law firm Mayer Brown about the legality of Gensler’s maneuvers, one of the people said.
A lawsuit could be filed as early as this week, the person said.
Scalia didn’t respond to requests for comment. Liz Pierce, a Sifma spokeswoman, declined to comment. Steven Kennedy, a spokesman for Isda, said today that the association is “extremely concerned” that the CFTC’s cross-border policy could damage market liquidity.
Rob Nichols, the president of the Financial Services Forum in Washington, which represents the chief executives of the major Wall Street firms, said that his members want to make sure that regulators in the U.S. and Europe are “rowing in the same direction” so the global swaps market isn’t disrupted. Gensler’s guidance on foreign trading is “counter-productive,” he added.
“Both market participants and his fellow regulators are raising concerns with the arbitrary process of the rule-making at the CFTC,” Nichols said.
Banks and their traders had been leaning on a few sentences deep in the agency’s July guidance -- footnote 513 -- to avoid CFTC oversight by setting up swaps deals in the U.S. and then booking them in London affiliates. The industry reacted with surprise when the CFTC on Nov. 14 issued a staff advisory closing the loophole.
According to one person involved in the decision on taking legal action, the suit would focus among other arguments on the lack of cost-benefit analysis in the advisory.
The other purpose of filing a case, the person said, would be to put Gensler on notice that he cannot issue a series of regulations by fiat on his way out the door. The suit would also give some cover to Massad if he and other commissioners decide to reverse Gensler’s actions, the person said.
The CFTC released its Nov. 14 advisory after Bloomberg News reported on the loophole that the banks’ lawyers had discovered. The advisory explains that traders based in the U.S. who arrange, negotiate or execute a deal -- even on behalf of an overseas affiliate -- must comply with Dodd-Frank. Along with its potential to disrupt their current deals, the banks are concerned that the language in the opinion is so broad that it could expose their overseas deals to even more regulation.
The policy quickly drew complaints from Congress as well. Staff members in the House and Senate held a briefing Nov. 22 with senior CFTC lawyers to explore what led to the recent action and what it means for the industry, according to aides with knowledge of the meeting. Republican lawmakers have said publicly that Gensler is acting as a rogue chairman, issuing guidance without consulting commissioners or telling the financial market when it needs to be followed.
Gensler’s latest move drew support from Senator Carl Levin, a Michigan Democrat who has investigated Wall Street trading practices, who said it was necessary to close off an “offshore gimmick” for banks to evade oversight. Americans for Financial Reform, a group of labor unions and consumer watchdog organizations, also praised the advisory.
Michel Barnier, the European Union’s financial services chief expressed reservations. His spokeswoman, Chantal Hughes, said Nov. 20 that “we were very surprised by the latest CFTC rules, which seem to us to go against both the letter and spirit” of the division of oversight agreement Gensler hammered out with the EU in July.
The advisories that Gensler has issued since late September extend beyond foreign trading rules. One warned swap-trading platforms not to limit trades to dealer banks. Any such effort to keep out traditional buyers of derivatives, such as hedge and pension funds, or have them play by different rules, would be against the law, the CFTC said Nov. 14.
Gensler is also trying to push through rules before the end of the year that would require greater transparency in the futures market. The proposal being prepared at the agency is a response to actions taken last year by CME Group (CME) Inc. and Intercontinental Exchange Inc., the two largest futures exchanges, to switch energy swaps to the futures market.
(Bloomberg LP, parent of Bloomberg News, operates a trading platform known as a Swap Execution Facility. The company asked a federal court to force the CFTC to limit the shift of swaps to futures. A judge dismissed the lawsuit, saying that Bloomberg had neither the standing nor the facts to support its case.)
On the Volcker rule, Gensler has been demanding changes that would restrict the ability of banks to make portfolio-wide hedges.
Two weeks ago, he sent banking regulators a series of edits he wanted to incorporate in the rule, describing some of them as changes in tone, people briefed on the negotiations said.
While White House officials and Treasury Secretary Jack Lew have said they want the Volcker rule finished by the end of the year, Gensler told Obama on Nov. 12 when he visited the White House for a press conference on Massad’s nomination that there was only a 50-50 chance that regulators would be able to meet that deadline, three people briefed on the meeting said.
Gensler declined to comment, preferring to keep his counsel to the president private, CFTC spokesman Steve Adamske said.
The chairman’s last-minute demands have also strained relations internally at the CFTC, people familiar with the discussions said. Gensler distributed the current draft of the Volcker rule to the other commissioners after their counterparts at the SEC and other regulators had already received it.
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