The chairman of the Commodity Futures Trading Commission says that excluding swaps between foreign branches of U.S. companies and offshore organizations r4om Dodd-Frank reforms is not an option.
Speaking at the Financial Industry Regulatory Authority’s annual conference, CFTC chair Gary Gensler said that a piece of U.S. legislation, House Bill 3283, would lead to “vast parts of the swaps market not coming under reform.''
That bill would reduce regulators ability to spot risks to the financial system, at home and abroad. And that the commission, which has been charged with implementing new rules on swaps reform coming out of the 2010 Dodd-Frank Wall Street Reform Act, would seek public comment on how to go about applying U.S. reforms abroad.
The commission will “soon seek public comment on guidance” regarding cross-border application of the derivatives market rules mandated by Dodd-Frank.
The commission will work with regulators at home, such as the Securities and Exchange Commission, and abroad to find an “appropriate and balanced approach” to making as many credit-default, interest-rate and other swaps standardized and details transparent to market participants and regulators.
At issue: Swaps that involve foreign entities.
Some market participants “contend that as long as an offshore dealer is regulated in some capacity elsewhere, many of the Dodd-Frank regulations applicable to swap dealers should not apply,’’ Gensler said.
But the “complex web of affiliates” belonging to Lehman Brothers in 2008, which shut down suddenly during the credit crisis that exploded in September of that year, as well as prior failures of investment bank Bear Stearns and hedge fun Long-Term Capital Management are evidence that swaps reforms must be applied effectively across borders, he said.
He said CFTC staff soon will issue a release on cross-border application of Dodd-Frank’s swaps reforms. And seek comment on how to apply them.
The key elements of the staff recommendations are likely to include:
◦ First, when a foreign entity transacts in more than a de minimis level of U.S. facing swap dealing activity, the entity would register under the CFTC’s recently completed swap dealer registration rules.
◦ Second, the release will address what it means to be a U.S. facing transaction. I believe this must include transactions not only with persons or entities operating in the United States, but also with their overseas branches. In the midst of a default or a crisis, there is no satisfactory way to really separate the risk of a bank and its branches. Likewise, I believe this must include transactions with overseas affiliates that are guaranteed by a U.S. entity, as well as the overseas affiliates operating as conduits for a U.S. entity’s swap activity.
◦ Third, based on input the Commission has received from market participants, the staff recommendations will include a tiered approach for requirements for overseas swap dealers. Some requirements would be considered entity-level, such as for capital, risk management and recordkeeping. Some requirements would be considered transaction-level, such as clearing, margin, real-time public reporting, trade execution and sales practices.
◦ Fourth, such entity-level requirements would apply to all registered swap dealers, but in certain circumstances, overseas swap dealers could comply with these requirements through substituted compliance.
◦ Fifth, such transaction-level requirements would apply to all U.S. facing transactions, but for certain transactions between an overseas swap dealer (including a foreign swap dealer that is an affiliate of a U.S. person) and counterparties not guaranteed by or operating as conduits for U.S. entities, Dodd-Frank may not apply. For example, this would be the case for a transaction between a foreign swap dealer and a foreign insurance company not guaranteed by a U.S. person.
Swaps, he noted, now constitute a $700 trillion global market, in face value.
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