Is JSCC-CFTC stalemate about to be broken?

For 12 years, Japan Securities Clearing Corporation has been trying to convince the Commodity Futures Trading Commission that it should allow US buy-side firms to trade yen interest rate swaps at the clearing house via client clearing relationships.

It got close in 2020, when the US derivatives regulator voted on a proposal to allow foreign clearing members to clear on behalf of US clients at so-called exempt derivatives clearing organisations (DCOs), such as JSCC. It didn’t pass, due to concerns that conflicts of bankruptcy law between the US and foreign jurisdictions would lead to risks for US clients, and the country’s economy.

Four years on, JSCC is hopeful that the CFTC will vote again, this time in its favour.

What’s changed? Conflicts in US and Japanese law remain, as do the CFTC’s concerns about them. The difference this time, perhaps, is that what JSCC is lobbying for has growing support not only from the US investment industry but from some prominent US politicians as well.

The yen swap market has seen a sustained shift in liquidity away from LCH to JSCC in recent years, to the extent that JSCC now boasts roughly 70% market share in Japan. Better liquidity means better pricing; something European hedge funds like Capula Investment Management and Rokos Capital Management have enjoyed at JSCC for years now.

Recent Bank of Japan rate hikes have intensified US firms’ demands for JSCC access, a sentiment echoed by the Alternative Investment Management Association (Aima) in a letter to the CFTC, criticising the unlevel playing field for US firms hedging yen interest rate risk.

The industry’s recent lobbying efforts might also explain the political attention that this rather obscure detail of US derivatives law is now getting. Members of Congress have raised the issue several times in the past year, most recently in a question put to CFTC chairman Rostin Behnam by Senator John Boozman at the Senate Appropriation Committee hearing on June 13.

Senator Boozman’s question to Behnam – echoing Aima’s letter – spoke of US customers being put at a “disadvantage” in markets such as Japan, before asking Behnam if he would commit to allowing those customers to access overseas clearing services “to ensure a level playing field”.

In a somewhat guarded response, Behnam said the commission would continue to work with clearing institutions that want to register with the CFTC or fall within an “exempt classification”. However, he then went on to emphasise his concerns regarding customer safety when it comes to extending access to overseas clearing services. Some jurisdictions, he cautioned – a possible reference to Japan – do not have parallel bankruptcy laws that provide the same protections as US laws. 

No need for US hedge funds to call their futures commission merchants (FCMs) about opening a JSCC account just yet then.

Low-hanging fruit

JSCC now appears reconciled to the fact that achieving a rule change is too politically difficult. Instead, the CCP is pushing for the CFTC to grant an exemption that would apply to US customers wishing to access only its yen swaps clearing service.

The CFTC has the authority under the Commodity Exchange Act to provide an exemption for any transaction or class of where it deems it to be in the public interest. But for this to happen, JSCC’s request will need to be put to the commissioners to vote upon – though it’s unclear whether Behnam’s recent remarks indicate an unwillingness to take such a step.

For its part, JSCC believes the differences in bankruptcy laws do not necessarily mean the US and Japan frameworks are incomparable. After all, JSCC and the Japanese regulatory regime have already been assessed by the CFTC as comparable to the US regulatory regime, which was required to get its exempt DCO status in the first place.

As required by US law, the clearing house also has trust arrangements in place to ensure bankruptcy remoteness of customer funds from JSCC. Furthermore, under JSCC rules, clearing brokers must not hold customer collateral but deliver it to the clearing house immediately, which reduces the possibilities of FCMs going under while holding customer collateral.

Perhaps the only point of contention is that there is a period of time when, technically, customer funds are not segregated, since Japanese law requires that the funds first go into a Bank of Japan settlement account.

JSCC also points to the CFTC’s long-standing regime for retail customers’ access to foreign futures markets under the ‘CFTC rule part 30’, which allows them to use FCMs without binding those exchanges to the US rules on bankruptcy protection.

It seems reasonable to argue – as JSCC does – that if retail can access foreign clearing houses that don’t necessarily meet the US bankruptcy standards, major US institutional investors should have sufficient risk management and compliance resources to make their own thorough assessment of the robustness of the Japanese bankruptcy framework.

For all these reasons, JSCC and US investment firms argue that the requested exemption for yen swaps could represent relatively low-hanging fruit for a commission that’s recently been beset by internal divisions to coalesce around, vote on, and – finally – get over the finish line.

But with two Democratic commissioners recently taking up new roles at other US agencies, it remains to be seen whether any votes can be carried this side of the November US presidential election without the Republican commissioners’ support, meaning the stalemate could continue for some time yet.

Editing by Lukas Becker