Extent of Clampdown on Overseas Swaps Gets Vote by SEC

The Securities and Exchange Commission plans to vote tomorrow on a plan that will define how far its regulations reach into a segment of the $710 trillion global swaps market.

The SEC’s rule will outline how new requirements apply to derivatives traded by foreign divisions of U.S. banks including JPMorgan Chase & Co. and Goldman Sachs Group Inc. The new rule comes as Wall Street takes steps to restructure trades overseas to avoid Dodd-Frank Act regulations intended to increase competition and price transparency.

U.S. regulators have faced a backlash from European and Asian authorities for overreaching in their desire to apply Dodd-Frank rules overseas. Meanwhile, Wall Street lobbying organizations have sued the Commodity Futures Trading Commission, which is the primary U.S. regulator of derivatives, to limit the international scope of the agency’s power.

“The SEC has no excuse not to strongly regulate Wall Street’s overseas derivatives gambling,” Dennis M. Kelleher, president of Better Markets, a Washington-based nonprofit that advocates stricter bank regulation, said in an e-mail.

Cross-border application of U.S. derivatives rules is one of the most contentious features of the Dodd-Frank Act, the regulatory expansion enacted after the 2008 credit crisis. Dodd-Frank gave the SEC authority over trading in equity and some credit-default swaps, about 5 percent of U.S. swaps, while the CFTC oversees the rest: swaps on interest rates, currencies, and credit indexes.

Split Market

David Felsenthal, a New York-based partner at the Clifford Chance law firm, said the split oversight could cause problems for credit-default swaps.

“It will be very difficult if there is any inconsistency to try to mesh the two markets together,” Felsenthal said in a phone interview.

The SEC’s blueprint to regulate cross-border swaps, issued in May 2013, proposed to exempt U.S. banks’ overseas affiliates from registration when they deal predominantly with foreign clients. The plan also outlined plans for allowing so-called substituted compliance, in which the agency wouldn’t enforce its own standards when foreign banks are complying with comparable overseas laws.

Critics of the SEC’s approach faulted the agency last year for taking a different approach than the CFTC, which oversees about 95 percent of the U.S. swaps market. Others said the SEC’s strategy would allow banks to escape regulation by moving more swaps deals offshore, which would raise the risk that an affiliate’s collapse could harm the U.S. parent company.

Guaranteed Affiliates

The SEC’s final rule should cover any trading by an affiliate whose trades are guaranteed, whether legally or implicitly, by its U.S. owners, said Better Markets’ Kelleher.

“They have seen how Wall Street has evaded the CFTC’s rules since last July,” Kelleher said. “We have spent hours with the SEC staff discussing this and a straightforward solution: Directly prohibit de facto guarantees, Wall Street’s latest tactic to avoid sensible and necessary rules.”

The Federal Deposit Insurance Corp., which regulates Wall Street banks, has said it is monitoring the move by banks to remove parent guarantees from affiliates or specific transactions so they can trade in the interdealer market free of many Dodd-Frank restrictions. The CFTC is reviewing the overseas changes and analyzing whether there is “evasive activity under way,” Commissioner Mark P. Wetjen said on May 14.

Market Fracturing

Under CFTC guidelines, overseas affiliates that lack a parent guarantee fall under fewer restrictions than do foreign branches or guaranteed affiliates of U.S. banks. As a result, the swaps market is fracturing with trades in the U.S. falling under Dodd-Frank and trades elsewhere being subject to local laws.

Trades with non-U.S. participants are occurring off of the new Dodd-Frank swap-execution facilities because they are being done by the non-guaranteed subsidiaries, John Nixon, an executive at London-based ICAP Plc, the world’s largest interdealer broker, said at an advisory meeting of the CFTC on May 21.

The U.S. House voted 265-144 to approve legislation today that would restrict the CFTC’s ability to impose rules overseas, among other changes to the agency’s authority over agriculture, energy and financial markets.

(Bloomberg LP, parent of Bloomberg News, operates a swap-trading platform and swap data repository.)

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