Isda chairman: US banks could be hamstrung by Dodd-Frank

Isda chairman warns House Committee on Agriculture that extraterritorial application of swaps proposals could make US banks less competitive

The extraterritorial application of US prudential regulators' margin proposals for uncleared swaps could put US firms at a significant competitive disadvantage to their foreign counterparts, Stephen O'Connor, the newly elected chairman of the International Swaps and Derivatives Association, warned a US House Committee on Agriculture hearing on global derivatives reform in Washington, DC today.

"By subjecting the non-US activities of non-US swap dealers of American banks to the margin requirements, these proposed rules potentially establish a framework that would create significant competitive issues for swap dealers affiliated with American holding companies. US banks are global in nature. Large components of their businesses are based in foreign countries and generally operated through subsidiaries or branches. If the framework described above for margin rules were to be adopted more broadly by US regulators that could create serious issues for US competitiveness," O'Connor said.

The testimony echoes concerns voiced by senator Chuck Schumer, who together with a group of 17 other Congressmen, wrote a letter to the US regulators on May 17 urging them to amend the proposals, which they claim will hamper US firms operating globally.

According to the prudential regulators' proposals, which were drafted by five agencies, including the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, the margin rules apply to all covered swaps entities - essentially, bank swap dealers and major swap participants. The Commodity Futures Trading Commission (CFTC) is responsible for determining which entities will register as swap dealers.

The proposals lay out prescriptive - and potentially costly - requirements for the calculation, posting, collection and segregation of margin in uncleared derivatives trades.

If the framework described above for margin rules were to be adopted more broadly by US regulators that could create serious issues for US competitiveness

The only exemption is for foreign covered swaps entities transacting foreign derivatives transactions. A foreign covered swaps entity is defined as a covered swaps entity that is not a company organised under the laws of the US, is not a branch or office of a company organised under US law, is not a US branch, agency or subsidiary of a foreign bank, and is not controlled directly or indirectly by a company that is organised under the laws of the US.

Meanwhile, a transaction would only be classed as a foreign non-cleared swap if the counterparty is not a US company, branch of a US company or US person, and the obligations have not been guaranteed by an affiliate of the counterparty that is a US company, branch of a US company or US person.

A lot rests on the CFTC definition of swap dealer and major swap participant, but as things stand, an uncleared swap would only be exempt from the margin proposals if a wholly foreign covered swaps entity conducts a trade with a wholly foreign counterparty - an exemption many lawyers have categorised as extremely narrow. This would give non-US customers a real incentive to trade with foreign banks and avoid US dealers, O'Connor warned the committee.

"If derivative transactions between an Italian company and the UK subsidiary of an American bank were subjected to transaction-level Dodd-Frank rules, such as margin rules or rules requiring clearing or electronic execution, but similar transactions between a German company and a UK bank without a US parent were not subject to those same rules, the end result would be that foreign companies would avoid doing business with swaps dealers affiliated with American companies. They would instead transact with non-US financial institutions not covered by the scope of these margin requirements," he argued.

A detailed feature looking at the extraterritorial application of US swaps rules will appear in the June issue of Risk.