The Giancarlo spirit: wobbling but not falling

Three years ago, the then-chairman of the US Commodity Futures Trading Commission, Christopher Giancarlo, embarked on a tour of Asia, during which he apologised for the over-zealous extraterritoriality rules the agency had been responsible for over the years, and promised to do something about them.

This stance drove a sharp drop in the basis between LCH and the Japan Securities Clearing Corporation, as the market realised US clients might now be allowed to choose on which platform they clear swaps. The JSCC is not fully registered with the CFTC, whilst the LCH is.

But the market is still waiting.

The latest setback came towards the end of last year, when some commissioners at the CFTC voted against a proposal that would have allowed US customers to clear at those firms that do not yet have CFTC derivatives clearing organisation status.

Dan Berkovitz was one of these commissioners. In his dissenting opinion, he said: “The proposal would jeopardise US customers, create systemic risks to the US financial system, promote the use of foreign intermediaries at the expense of US firms, and exceed this agency’s limited exemptive authority.”

Why, argued Berkovitz, should US entities be subject to the whims of a foreign bankruptcy regime over which their home regulator has no direct jurisdiction?

It’s not an unreasonable point to make – but it is one that now demands a solution.

There are clear benefits for US customers to be able to clear some of their trades, especially long-dated yen swaps, at JSCC since this is where the bulk of liquidity sits.

Of course, the blame shouldn’t sit entirely with the CFTC. The Japanese Financial Services Agency (JFSA) has also not shied away from market protectionism, most notably in refusing to allow the LCH to trade Japanese yen swaps onshore (although the UK firm does have permission to trade non-yen swaps in the country).

While officials at the JFSA are happy to denounce the ills of market fragmentation, they have repeatedly ducked the question of whether the LCH will ever be granted a licence for clearing yen swaps onshore. Were this to happen, then the problem of US entities not being able to clear at the JSCC would be lessened.

Such national protectionism is, perhaps, understandable. The fear is that, should the LCH be granted a yen clearing licence in Japan, then liquidity will suddenly jump off the JSCC – and the JFSA can’t let that happen to their national clearing house.

But solutions need to be found, which is why it is heartening to see that Rostin Behnam, acting chairman for the CFTC, has indicated discussions will continue.

US President Joe Biden has yet to nominate the next chair of the CFTC, but whoever it is should keep up the momentum that is already in place to ease the burden of US extraterritoriality rules. Financial markets are inherently cross-border in nature. They need a legal framework that matches.