CFTC-SEC cross-border split could 'tarnish' US swap markets

Capitol Hill

The heads of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) endured a grilling on Capitol Hill yesterday over their divergent approaches to the cross-border application of the Dodd-Frank Act.

SEC chair Mary Jo White and CFTC chairman Gary Gensler both sought to put a gloss on their respective agencies' progress in implementing Dodd-Frank, but the ranking Republican member on the committee instead honed in on the lack of harmonisation between the two regulators' cross-border rules – in particular, the ambiguities that continue to bedevil the final CFTC cross-border guidance published on July 12.

"The CFTC's initial proposal for the cross-border implementation of Title VII received criticism both domestically and in foreign markets as being confusing, over-expansive and harmful. The final cross-border interpretive guidance released by the CFTC continues to raise questions both as to its substance and the process surrounding its issuance," said ranking Republican member Mike Crapo.

"The SEC proposed its own cross-border rule on May 1. The public is now faced with two marginally similar plans from two agencies issued through two very different processes – the CFTC though interpretive guidance and exemptions, and the SEC through notice and comment rulemaking. Our capital markets cannot be tarnished by two regulators that appear to be going in two different directions and appear not to be working effectively with each other and their international counterparts. If the current lack of co-ordination persists, it would not be surprising to me to hear additional calls for merging the two agencies into a single regulator for the securities, futures and swaps markets," Crapo added.

At the CFTC meeting to pass its final cross-border guidance on July 12, the SEC's own proposals were barely mentioned. Staff and commissioners did not identify any changes made to the CFTC guidance in light of the securities regulator's stance.

The final cross-border interpretive guidance released by the CFTC continues to raise questions both as to its substance and the process surrounding its issuance

When the SEC unveiled its proposed rules on the extraterritorial reach of its security-based swap regulations two months previously, commission staffers said the agency had looked at the furore the CFTC sparked with its proposed interpretative guidance and consequently moderated its proposed measures in response.

Nonetheless, both chairmen said that despite the differences in approach, the two agencies have been co-ordinating their reform efforts since before the Dodd-Frank Act was even signed into law.

"We have been co-ordinating going back to the legislative phase. If we sent a term sheet or a draft memo to our commissioners, we sent it to the SEC and other regulators. We do have some differences and there are some differences in the laws themselves," said Gensler. "On cross-border, congress expressly had instruction for the CFTC that was not included for the SEC, which was [to consider in the guidance extraterritorial activities that have] a 'direct and significant connection with activities in or effect on, commerce of the US'. That is what we were asked to give some guidance on and we did so."

White agreed that co-operation was ongoing before her recent appointment to the SEC, although she acknowledged more could be done.

"There may be some differences because these are different markets, but we need to strive for consistency, avoiding duplication and disruption. The staff have been sharing drafts and having discussions, but obviously differences do remain. In our proposal we tee up that consistency question, and going forward, I would like to see an increase in the depth of engagement at the principle level and staff level," White said.

Crapo warned the lack of co-ordination has broad ramifications – going beyond differences between the two US regulators and possibly threatening the prospects for cogent regulation of swap markets on an international scale.

He argued the CFTC and the European Commission's joint "path forward on derivatives" – ostensibly an agreement that sets the foundation for substituted compliance between the two authorities – is extremely unclear, sharing many of the same ambiguities and open questions as the CFTC's own final guidance. The CFTC rules have been roundly criticised by bank and private practice lawyers for failing to provide clarity on when and how non-US entities will be able to apply local rules instead of the US regime.

"In the hours leading up to the CFTC's final guidance, the commission and European regulators issued a joint statement on how international co-ordination of rulemaking should proceed. This path forward has been characterised as an agreement, when it appears to be just a statement of future collaboration. While this statement may be constructive, a number of questions still remain. How will conflicts in rules for central clearing houses be addressed across borders? We need more information about what agreement, if any, has been reached for the treatment of margin for end-users? With these questions unanswered it is clear that there is a lot of work that needs to be done on international harmonisation," Crapo concluded.

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