Banks urge co-ordinated Asian reaction to CFTC swaps rule

Banks call for Asian regulators to unite against US supervisory overreach

Hard place: Asian regulators are mulling a joint push-back against US rules

Banks based in Asia are calling on regional regulators to adopt a co-ordinated response to far-reaching proposals from the US Commodity Futures Trading Commission (CFTC) that would see Asia-based swap dealers having to register in the US to continue trading with US entities.

"Why, as a regional Asian bank, with hardly any US operations, do I want to be subject to CFTC rules, with all [the] regulatory and reporting and settlement issues that's going to entail? It's ridiculous," says the senior manager within the treasury department of an Asian bank.

On October 18, the CFTC unveiled a proposed rulemaking on cross-border application of the registration thresholds and external business conduct standards for swap dealers and major swap participants. Responses are due by December 19.

If enacted, the proposal will force all non-US swap dealers to register with the US regulator if their notional derivatives exposure with US counterparties is above a specified minimum. This de minimis threshold would initially be set at $8 billion over a 12-month period, with the aim of eventually reducing it to $3 billion.

There now seems to be a firm understanding that this is not a small proposal and that it warrants a co-ordinated reply from Asian regulators
A regulatory expert at a US bank in Asia

The proposed rules would capture all trades done with subsidiaries of US banks or other institutions overseas, including in Asia. The rules would also broaden the definition of a US entity to include non-guaranteed subsidiaries of a US parent that are consolidated into the parent company's accounts.

The expansion of the CFTC's reach under the draft provisions is expected to provoke a response from regulators on the ground in Asia, who may see it as the US overstepping its authority.

"There now seems to be a firm understanding that this is not a small proposal and that it warrants a co-ordinated reply from Asian regulators," says a regulatory expert at a US bank in Asia.

Bronwen May, a derivatives partner with law firm Hogan Lovells in Hong Kong, said: "What will be interesting is to see how the regulators in Hong Kong will react. Will they effectively say, ‘back off, this is my patch' or will they allow the CFTC to regulate this area?"

Serious concerns

Another Hong Kong-based regulatory expert at a US bank says there is an understanding that regulators in the region will submit a joint response to the proposal, raising concerns about the extraterritorial reach of the regulation, which "inappropriately captures foreign market participants, even if there is no direct or significant nexus back to the US".

Asian regulators have not made it clear whether they will be co-ordinating their submission to the CFTC, but one regulatory source says the industry's concerns are being taken seriously.

"In recent years, Asian regulators have been more visible and have been working quite well together, and this is something they collectively should provide feedback on and engage with the CFTC as early as possible in the process, particularly as the impact across Asian markets is likely to be quite similar," he says.

Although rare, a combined response would not be unprecedented. In 2012, reported Australia, Hong Kong and Singapore had written a joint letter to the then CFTC chairman, Gary Gensler, warning of the "unintended consequences" of the extraterritorial reach of the Dodd-Frank Act.

In 2015, the Asia-Pacific Regional Committee (APRC) of the International Organization of Securities Commissions (Iosco), outlined a road map for closer regional co-ordination. The regulatory source says there are now clear signs the idea is working.

A recent example of this, he says, is the co-ordinated publication earlier this month of guidelines on the implementation of non-cleared derivatives margin requirements from the Hong Kong Monetary Authority, the Monetary Authority of Singapore (MAS) and the Australian Prudential Regulation Authority.

In October, MAS also hosted a meeting between the Iosco APRC and officials from the European Commission, to launch a dialogue with the European Union about how future European legislation might impact the region.

Uncertain implications

There remains a lot of uncertainty over what the full implications of the CFTC proposal may be, if it is enacted. In its draft, the CFTC has said the additional number of swap dealers affected will be only 14. However, in sharp contrast, the second regulatory expert at a US bank puts the estimated figure in the thousands.

"I think we are all still trying to figure out the impact in that area. There is a lot of doom and gloom, and I think the proposal took us all a little bit by surprise," says a US-based private practice regulatory lawyer.

Exactly what the proposal means for swap dealers is unclear, since it only lays out the conditions under which dealers are caught and not what registration with the CFTC will entail. Some suggest it will just be an extra administrative burden, while others worry there could be capital implications as dealers are forced to hold collateral in the US.

It may also refocus attention on US rules requiring collateral to be posted the day after trading (T+1), which is unfeasible for many Asian jurisdictions, particularly Japan, whose day ends before trading in New York even begins.

One of the problems is the regulatory pace of each regulator is not aligned
Seiji Matsuzoe, White & Case

A key concern arising from the proposals is that the reluctance of outfits to register with the CFTC will hit liquidity in the region, as local dealers will be unable to trade with US banks that are major liquidity providers in the region.

"Liquidity sets will be bad," says the manager of the treasury department at an Asian bank. "If everyone says, ‘I don't want to be declared a CFTC major swap participant', then I can't trade with any US bank. [But] the big liquidity providers are US banks like Citi and JP Morgan. I can get some volume with HSBC and Standard Chartered, but then there will be a complete bifurcation in the market and it concentrates risk."

Others in the market echo this fear, adding the concern that there will be a particular impact on US dollar liquidity. The resulting drain on liquidity is predicted to make swaps more expensive because non-US banks, aware of the restrictions placed on their US counterparts, will price them wider.

"Then I have to pass the cost on to all my clients, and so the cost of banking is just going to go up in Asia because I can't deal with US banks. And the US banks will lose business, so they will have to push back as well," adds the treasury head.

This fear is compounded by an uncertainty about whether there will be any substituted compliance introduced into the new rules, and how this might work.

"One of the problems is the regulatory pace of each regulator is not aligned and it is still unclear how the substituted compliance regime works," says Seiji Matsuzoe, a Tokyo-based derivatives partner at White & Case. "[The] CFTC's new proposal makes [the] cross-border regulatory situation more complicated, so one of the main requests to the CFTC is to produce [a] comprehensive and practical regime of substituted compliance."

New CFTC head

However, the promise of new leadership at the CFTC, following the election of Donald Trump as president, has given hope that the regulator might be disinclined to push the extraterritorial aspects of Dodd-Frank.

Christopher Giancarlo, widely tipped to be the next chairman of the CFTC after current incumbent Timothy Massad steps down next year, has repeatedly expressed his view that US extraterritoriality has gone too far.

christopher-giancarlo-33Christopher Giancarlo

In a speech given to an International Swaps and Derivatives Association conference in London on December 9, Giancarlo said: "Trading market fragmentation caused by ill-designed rules and burdensome regulations – and the application of those rules abroad – is harming market liquidity, and market safety and soundness, increasing the systemic risk that the Dodd-Frank Act was predicated on reducing... The time has come for the CFTC to revisit its flawed swaps-trading rules to better align them to market dynamics, allow US swap intermediaries to fairly compete in world markets and reverse the tide of global market fragmentation."

Such words have given some comfort to those who are voicing concern about this latest attempt by the CFTC to exert its influence abroad.

"It seems on the surface of things that a Republican CFTC might be less interested in pushing this agenda forwards, but who knows?" says the second regulatory expert at a US bank.

"At this point there's still a broad range of options on the table, ranging from scrapping the proposal completely to making marginal amendments to it. We are giving all the information we can to the CFTC to help them understand some of the possible implications of their proposal. Hopefully, we can engage in a good dialogue with them and find something that works for everyone."

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