Banks worry over extraterritorial impact of Dodd-Frank

The extraterritorial application of US derivatives regulation looks set to put US banks at a significant competitive disadvantage to their foreign counterparts. Meanwhile, banks have been grappling with section 716 – the swaps push-out provision. By Matt Cameron

Sticks and stones may break bones, but words are never supposed to harm. Tell that to US banks, which claim to have been dealt a heavy blow by margin and capital proposals for non-cleared swaps, published by a group of US prudential regulators on April 12. The proposed rules make it clear the requirements will apply to the non-US swaps operations of US banks – an extraterritorial application of the Dodd-Frank Act that US firms say will put them at a huge competitive disadvantage in foreign jurisdictions.

“This will put US banks on an unlevel playing field with European or Asian banks,” says one derivatives lawyer at a US bank in New York. “No non-US counterparty is going to want to trade with us because the US margin requirements are more onerous. They’ll trade with a foreign bank – it’s a no-brainer. It’s also likely that interdealer hedging in foreign jurisdictions will become a lot more concentrated among non-US banks.”

The rules have also caused alarm among politicians. On May 17, a group of 18 Congressmen, led by senator Chuck Schumer, wrote a letter to US regulators urging them to amend the proposals given the likely competitive disadvantage for US banks operating abroad. Meanwhile, European regulators have expressed concern about the extraterritorial sweep of Dodd-Frank, and the potential for banks under their purview to be captured by the rules.

This is just the tip of the iceberg. The April 12 proposal was the first to explicitly tackle extraterritoriality, and focused specifically on bank swap entities, but other rules are now expected to follow. The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), together responsible for the vast majority of Dodd-Frank rule-making, have so far been silent on extraterritoriality, but many expect them to take a hard line, particularly now the prudential regulators have opted for an expansive approach in their margin and capital rules.

“Our worst fears have been realised,” says one lawyer based in New York. “We had not been expecting the US prudential regulators’ proposal to take such a broad view of their jurisdiction. For months, we had been very concerned by language included in the CFTC swap dealer registration proposals, which indicated the extent to which the CFTC was intending to extend its extraterritorial reach to non-US operations of US banks, but we didn’t expect the prudential regulators to adopt such a tack. It is highly unlikely the CFTC and the SEC will adopt a more narrow scope.”

The swap dealer registration rules, being drawn up by the CFTC, will be crucial in determining how far Dodd-Frank will reach. A proposal was released on November 23 last year, but exact details on which firms will have to register as swap dealers have yet to be finalised. The decision will be critical, as registered swap dealers will have to comply with all relevant sections of the Dodd-Frank Act – possibly even if that entity isn’t based in the US or primarily overseen by a US supervisor. Language in the November 23 proposal has prompted many to predict the CFTC will cast the net as wide as possible. Certainly, regulators are keen to ensure US dealers aren’t able to avoid the rules simply by shifting operations to overseas entities.

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Banks worry over extraterritorial impact of Dodd-Frank

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