The Commodity Futures Trading Commission’s Global Markets Advisory Committee met in Washington this week to discuss major issues related to implementation of swaps regulations that are supposed to go into effect at the end of the year. These regulations would affect the cost and reliability of farmers, ranchers, airlines, bakers and other entities as they use swaps to reduce the risk of their operations.
In her opening statement, Commissioner Jill Sommers said the CFTC has been working to coordinate swaps regulations with its international counterparts in order to develop a unified system for the global swaps market. This would “address the growing uncertainty brewing among swap-market participants who were trying to decipher the extraterritorial reach of the Dodd-Frank Act.”
Earlier this fall, the Commission issued a Proposed Interpretive Guidance and a Proposed Exemptive Order regarding Dodd-Frank, and another round of exemptions is in prospect for the end of the year in order to give market participants time to comply with the Act.
The Committee considered three issues:
• Definition of U.S. Persons.
The CFTC is required under Dodd-Frank to regulate all derivatives trading that involves U.S. persons. Firms that trade swaps with U.S. persons are required to register with the Commission by the end of the year if their activity exceeds $8 billion, which is not a lot in the swaps world.
The industry has complained bitterly about what it calls the “extraterritorial” application of the Act. For example, if two foreign entities enter into a swap, but they clear it through a U.S. trading platform, they would be subject to the Act. Committee members complained that there are several definitions of U.S. person under CFTC rules and that entities might be considered a U.S. person for some purposes and not for others or on some days and not on others.
• Regulation of Conduits.
Conduits come into play when the entity that formulates the deal is not the one that executes it. The Committee did not spend much time on this issue, but noted that it has full anti-fraud authority as well as authority under Dodd-Frank to prevent evasion of the Act.
• Substituted Compliance.
This term means that if an entity is doing business in a foreign jurisdiction that has equivalent regulations to those of the CFTC, it will not have to comply with both sets of regulations. To the extent major trading countries adopt similar regulations, the objections to extraterritorial application will be assuaged.
One idea that was discussed was that if the United States and European Union could get together on their regulations, this would cover 70 to 80 percent of the market. Other countries would then be faced with the choice of adopting the regulatory scheme or being left behind. This suggestion also contemplates that the regulators would concentrate on resolving the most critical issues, while deferring others in order to conserve time.
While this debate is taking place, the futures industry is developing products that would be designed to compete with futures, so that the business could legally escape swaps regulations the industry considers too complex and confusing.
Customers have said these products would be competitive with standard swaps, but not with those that need to be customized. With fewer than 30 working days left before firms would be required to register under the Act, Dan Roth, the head of the National Futures Association, which regulates futures commission merchants, urged the Commission not to wait until the last minute to grant the industry an extension of time to comply with the new regulations.
An expert recently told me that Gary Gensler, Chairman of the CFTC, lacks the needed majority of votes to convene the Commission and take action. This was borne out when the Commission recently cancelled a meeting that had been scheduled to propose swap regulations that are needed as counterparts to rules the Securities and Exchange Commission (SEC) has adopted.
Therefore, the prospect is for continued confusion and consternation to prevail for the indefinite future. Gensler’s term expires near next Memorial Day, and unlike SEC Chair Mary Schapiro, he appears to be seeking reappointment. It is unclear whether a new chairman would be able to break the deadlock, and it is also unclear what the re-elected administration plans to do regarding this post and several other financial regulatory appointments.
Robert Feinberg served on the staff of the House Banking Committee for the 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms and trade associations.
Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.
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