June 29, 2012
I respectfully concur with the Commodity Futures Trading Commission’s (the “Commission” or “CFTC”) approval of its proposed interpretive guidance and policy statement (“Proposed Guidance”) regarding section 2(i) of the Commodity Exchange Act (“CEA”)1 and its notice of proposed exemptive order (“Proposed Order”). While I have strong reservations about the statutory authority and disagree with the Commission’s decision to issue interpretive guidance instead of a formal rulemaking, I believe that the timely release of these proposals is critical for firms to have some sense of what U.S. standards will apply to their cross-border transaction, and how those standards will comport with international standards. We expect that these proposals will improve as a result of input from market participants, as well as an open dialogue with global regulators.
These two proposals are complementary in that the Commission’s long-awaited Proposed Guidance establishes our view of the application of the swaps provisions of the CEA to cross-border swaps transactions, while the Proposed Order will delay compliance with certain entity-level and transaction-level swaps requirements in the CEA pending the final adoption of the Proposed Guidance. The Proposed Order also borrows definitions and concepts from the Proposed Guidance, such as the proposed definition of “U.S. person.” While I believe that the Commission’s issuance of the Proposed Guidance and the Proposed Order are overdue, I have a number of general concerns with the former.
I have been assured that the Proposed Guidance is a draft and, although it is not required, will follow the normal notice-and-comment process under the Administrative Procedure Act.2 After the comment period, the Commission will review public comments and subsequently will incorporate those comments into final guidance. I would like to make it clear that if I were asked to vote on the Proposed Guidance as final, my vote would be no.
The Proposed Guidance
My concerns with the Proposed Guidance relate generally to the Commission’s unsound interpretation of section 2(i) of the CEA. In particular, I believe that the Commission’s analysis: (i) misconstrues the language of section 2(i); (ii) is inconsistently applied to different activities; (iii) loosely considers international law and comity; (iv) lacks meaningful collaboration with foreign and domestic regulators; and (v) blurs the lines between interpretive guidance and legislative or interpretive rulemaking. I discuss each of these concerns below.
i. Statutory Misconstruction
Section 2(i) of the CEA provides, in part, that the Commission’s swap authority does not apply to foreign activities unless those activities “have a direct and significant connection with activities in, or effect on, commerce of the United States . . . .”3 When Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”),4 it intended that section 2(i) act as a limitation on the Commission’s authority. Under section 2(i), the Commission is required to demonstrate how and when its jurisdiction applies to activities that take place outside of the United States. Instead, the Commission’s Proposed Guidance ignores the literal statutory construction of section 2(i) and prejudicially switches the analysis. In other words, the Proposed Guidance now places the burden on market participants to explain why their foreign swaps activities are outside of the Commission’s regulatory oversight. By placing the burden on market participants to determine whether their swaps activities are subject to the swaps provisions of the CEA—and without providing more guidance to these participants—the Commission inappropriately broadens the scope of swaps activities that will fall within the Commission’s jurisdiction. The Commission could more clearly delineate which activities it believes will have a direct and significant connection with U.S. commerce in order to ensure that our regulatory interests are preserved.5
ii. Inconsistent Application of CEA Section 2(i)
In addition, the Commission’s Proposed Guidance inconsistently applies, and sometimes ignores, its own section 2(i) analysis. For instance, the Commission sets forth in detail its belief that “the level of swap dealing that is substantial enough to require a person to register as a swap dealer when conducted by a U.S. person, also constitutes a ‘direct and significant connection’ within the meaning of section 2(i)(1) of the CEA.”6 As a result, a non-U.S. person would have a direct and significant connection with the United States and therefore have to register with the Commission as a swap dealer only once it engages in more than the de minimis level of swap dealing with U.S. persons.7 In contrast to this somewhat extensive analysis for swap dealers, the Commission provides a sparse explanation of why it believes each and every swap transaction between one or more U.S. persons or counterparties other than a swap dealer or major swap participant (“MSP”) satisfies the direct and significant connection analysis in section 2(i).8 Swap transactions that fall under this analysis would be subject to certain transaction-level swaps requirements, including clearing, exchange trading, reporting to a swap data repository under part 45 of the Commission’s regulations, real-time public reporting and large swaps trader reporting under part 20 of the Commission’s regulations.
Similarly, in another instance, the Commission has divined an exception to the application of certain Commission regulations for situations where a foreign branch of a U.S. swap dealer engages in swap dealing activities in emerging markets or other jurisdictions without comparable swaps regimes.9 Although the policy result of this exception is well intended, its bare analysis pales in comparison to the Commission’s section 2(i) analysis in other places of the Proposed Guidance.10
In yet another section of the Proposed Guidance, the Commission does not adequately explain why almost all transaction-level requirements (i.e., clearing, margining for uncleared swaps, real-time public reporting and certain business conduct standards) equally satisfy the direct and significant connection analysis under CEA section 2(i). In my view, two transaction-level requirements related to pre- and post-trade transparency—namely, trade execution and real-time public reporting requirements—do not raise the same level of systemic risk concerns as clearing and margining for uncleared swaps. I believe the Commission should better explain its rationale for requiring foreign swap dealers transacting with non-U.S. persons to meet the trade execution and real-time public reporting requirements under Title VII of the Dodd-Frank Act and Commission regulations.
iii. Loose Consideration of Principles of International Comity
Moreover, the Commission’s interpretation of CEA section 2(i) is overly broad to the point where the extent of the Commission’s jurisdiction is virtually endless. The Proposed Guidance takes the position that all transactions involving a U.S. person fall within the Commission’s jurisdiction, regardless of the location of the transaction or the regulations in effect within the relevant jurisdiction.
While section 2(i) gives the Commission jurisdiction to reach activities that take place outside of the United States, the Commission’s Proposed Guidance loosely considers principles of international comity that are essential for determining the extraterritorial applicability of U.S. law. Although the Proposed Guidance expressly states that the Commission will exercise its regulatory authority over cross-border activities in a manner consistent with principles of international comity, the Commission’s proposed approach could be described as unilateral and dismissive of foreign law, even when those laws may achieve the same results sought by the Commission.11
I strongly believe that the Commission instead must honor these principles in order to respect the legitimate interests of other sovereign nations. This approach would serve to complement, and not limit, the ability of the Commission to effectively regulate swaps markets. The Commission does not have the resources to register and regulate all market participants and swaps activities. By relying on comparable foreign regulatory regimes to address the trading activities of foreign market participants, the Commission could better allocate resources domestically in a more effective manner.
iv. The Commission Should Engage in Real and Meaningful Cooperation with Foreign and Domestic Regulators
The Proposed Guidance references a series of well-known large financial institution failures—such as Lehman Brothers and Long Term Capital Management—to support the Commission’s over-expansive interpretation and application of Title VII of the Dodd-Frank Act. I agree that those failures had a detrimental effect on the U.S. economy. We must not forget, however, that the swaps markets are truly global and the Commission’s swaps regulations will not operate in a vacuum. For that reason, the Commission should consider the interaction of its swaps regulations with the regulations of other jurisdictions, all of which have legitimate regulatory interests in the trading of swaps by multinational organizations. Thus, the Commission’s swaps regulation should be concordant with foreign swaps regulations in order to avoid duplication, conflict and unnecessary uncertainty.
In light of today’s highly interdependent, global financial markets, the Commission needs to engage in real cooperation with foreign regulators and to coordinate its swaps regulations with the regulations of other sovereign nations. Concepts of comparability and mutual recognition are essential.
The Commission should follow the example of international cooperation and coordination seen in the efforts of the Basel Commission on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions ("IOSCO”) in developing harmonized international standards for the margining of uncleared swaps. BCBS and IOSCO plans to publish a consultation paper outlining these standards. Notwithstanding the Commission’s own efforts to propose rules for the margining of uncleared swaps for swap dealers and MSPs,12 the Commission plans to consider the final policy recommendations set forth by BCBS and IOSCO when adopting the Commission’s final rules for the margining of uncleared swaps and may adapt those final rules to conform with BCBS and IOSCO’s final policy recommendations. The Commission should follow the lead of BCBS and IOSCO in harmonizing many of its other rules. In my view, either the G20 or another international body or consortium of nations could act as a springboard for the coordination of swaps regulation.13
On June 22, 2012, European Union Commissioner Michel Barnier echoed this position in a statement to the Financial Times.14 Mr. Barnier made clear that effective international regulation involves regulators coordinating their efforts to implement mandatory clearing, trading and reporting of over-the-counter derivatives. A coordinated approach would ensure that swaps do not evade regulation. Mr. Barnier also made clear that regulatory regimes that assert jurisdiction over trading activity already within the jurisdiction of another competent regulator is both unnecessary and costly. I agree with Mr. Barnier’s view that our goal as regulators should be to establish regulatory regimes that prevent swaps from slipping through the cracks without applying our laws to activity that is better regulated by our trusted colleagues abroad.
Unfortunately, the Proposed Guidance overreaches in many respects and, as a result, steps on the toes of other sovereign nations. Today’s Proposed Guidance will likely provoke these nations to develop strict swaps rules in retaliation that unfairly and unnecessarily burden U.S. firms.15
Interestingly, we not only fail to harmonize internationally, we also fail to harmonize domestically. In other words, I believe that the Commission should take a page from the Securities and Exchange Commission’s (“SEC”) playbook regarding implementation and the application of swaps requirements to cross-border activities. Recently, the SEC issued a statement of general policy (the “SEC’s Statement”) on the sequencing of compliance dates for final rules applicable to the security-based swaps market.16 The SEC’s Statement presents a commonsense sequencing of the compliance dates for the SEC’s final rules implementing the provisions of Title VII of the Dodd-Frank Act to domestic and cross-border swaps activities.
In stark contrast, the Commission is engaging in what amounts to high-frequency regulation. I am very critical of this regulatory approach because it generally results in regulatory uncertainty and unintended, adverse consequences. In my view, failure to achieve real and meaningful harmonization of the implementation and application of swaps and security-based swaps rules will result in inconsistencies and added compliance challenges and costs for market participants who trade in both markets.
v. Interpretive Guidance or an Interpretive Rule?
Several times while reading drafts of the Proposed Guidance, I had to stop, put it down, and recall that I was reading the Commission’s proposed interpretation of CEA section 2(i)—not a prescriptive rule. Although the Commission has taken great pains to clarify that it is publishing guidance and a policy statement regarding the cross-border application of the swaps provisions of the CEA, certain elements of the Proposed Guidance are written similar to legislative or interpretive rules instead of interpretive guidance. For example, the Proposed Guidance states that subsequent to registration with the Commission:
[T]he Commission expects that a non-U.S. swap dealer or non-U.S. MSP would notify the Commission of any material changes to information submitted in support of a comparability finding (including, but not limited to, changes in the relevant supervisory or regulatory regime) as the Commission’s comparability determination may no longer be valid.17
The Commission’s artful use of the terms “expect” and “expectation” in the Proposed Guidance does not disguise the fact that it is requiring applicants to satisfy significant ongoing monitoring and compliance obligations in order to maintain its comparability finding. If the Commission wanted to require a non-U.S. swap dealer or non-U.S. MSP applicant to submit these additional documents in connection with such applicant’s ongoing registration-related obligations, the Commission should have included these requirements in the swap dealer and MSP registration rulemaking, which the Commission finalized in January of this year.18 Instead, the Commission is issuing today’s Proposed Guidance in a manner that is outside of the requirements set forth in the Administrative Procedure Act.19
The Proposed Order
Notwithstanding my general concerns with the Proposed Guidance, I believe that the Commission’s Proposed Order appropriately provides both U.S. and foreign firms with transition periods in which to comply with the Commission’s interpretation of CEA section 2(i). As noted above, the Proposed Order would permit foreign swap dealer and MSP registrants to delay compliance with certain entity-level requirements and transaction-level requirements under Title VII of the Dodd-Frank Act pending the adoption of the Commission’s final interpretive guidance regarding section 2(i). My concurrence today comes after several days of negotiations with my fellow commissioners. I am relieved that we are protecting the competitiveness of U.S. firms in the Proposed Order.20 Although I am generally supportive of the Proposed Order, I do have a couple of more pragmatic concerns regarding the manner in which foreign swap dealers and MSPs will comply with the Commission’s registration requirements.
First, I believe the Commission should tie the expiration of this relief to the adoption of a final exemptive order. Currently, the Proposed Order unjustifiably ties the expiration of the relief to the date on which the Proposed Order is published in the Federal Register. The Proposed Order’s current expiration does not make sense in light of the fact that potential registrants will not know the contours of the final relief until the Commission approves a final exemptive order. If we do not tie the expiration of relief to the publication of the final exemptive order, are we truly providing adequate notice and a period of time in which registrants can comply?
Second, the Proposed Order should at least include questions regarding how the Commission proposes to address practical considerations regarding the registration of foreign swap dealers and MSPs. The Commission should set out its preliminary thinking regarding how these foreign swap dealers and MSPs will register their associated persons and principals, in addition to addressing concerns regarding the transfer of, and withdrawal from, Commission registration.
I have included a few questions at the end of my statement to address these practical concerns.
Do Not Ignore the Significant Cost Implications
I would like to make one closing but important point regarding the potential costs of today’s Proposed Guidance. While I understand that the CEA only requires the Commission to consider the costs and benefits of its regulations and orders—not interpretive guidance—the Proposed Guidance, once finalized will result in significant costs to the swaps industry. The implications of the Commission’s adoption of interpretive guidance on cross-border swaps activities will be nothing at which to laugh. Firms will incur significant operational, legal and administrative expenses in connection with the registration and ongoing compliance with the Commission’s swaps regulations. Not to mention, many firms that operate through branches may feel compelled to convert into, and separately capitalize, affiliates in order to limit the impact of the Commission’s interpretation.
Accordingly, I encourage the Commission to prepare a report separate from its adoption of the Proposed Guidance, which analyzes the costs attributable to the breadth of the Commission’s new authority under CEA section 2(i). This report will help inform market participants who seek guidance as to the potential costs of trading swaps in the United States. More importantly, the report will help inform the Commission in connection with the issuance of future rulemakings under Title VII of the Dodd-Frank Act.
I am relieved that the Commission is finally issuing today’s proposals. Commission staff has spent well over one year preparing the proposals before us today. The publication of the Commission’s interpretation of CEA section 2(i) is crucial. I hope that the release of these proposals will enable market participants to determine how the international rules and expansive international oversight of the Dodd-Frank Act might impact their activities in the United States and internationally. I want to ensure that U.S firms are placed on a fair and competitive playing field that offers no opportunity for regulatory arbitrage. I am mindful that a seamless regulatory net can only be achieved through international cooperation and coordination.
In summary, I believe the Commission’s final interpretive guidance should reflect: (1) principles of international law and comity; (2) a clear understanding of the implications of the Proposed Guidance so that the Commission can make an informed decision regarding the various policy alternatives; and (3) parity to ensure that U.S. firms are not unfairly disadvantaged vis-à-vis their foreign competitors. I fear that if we adopt the Proposed Guidance as final, the Commission will take an imperialistic view of the swaps market. I also remain concerned regarding the Commission’s shaky legal analysis.
I look forward to reviewing the myriad of comments submitted in response to today’s proposals. I implore market participants, as well as domestic and foreign regulators, to share their views and let us know how to harmonize our efforts so that we collectively can develop an internationally consistent and complementary approach to address the cross-border regulation of the swaps markets.
1 See 7 U.S.C. 1 et seq.
2 See 5 U.S.C. 551 et seq.
3 7 U.S.C. 2(i) (2012).
4 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
5 For example, in the case of non-interdealer swap transactions, the Commission could focus its analysis on the solicitation activities of swap dealers. In the case of other swap transactions, the Commission could examine the location of where performance of the primary obligations under a swap agreement takes place.
6 The Commission’s analysis in the Proposed Guidance relies on its analysis in the final entities rule. See Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant,” and “Eligible Contract Participant,” 77 Fed. Reg. 30596 (May 23, 2012).
7 See 77 Fed. Reg. at 30634 (“[T]he Commissions believe that the appropriate threshold for the phase-in period is an annual gross notional level of swap dealing activity of $8 billion or less. In particular, the $8 billion level should still lead to the regulation of persons responsible for the vast majority of dealing activity within the swap markets.”). The Commission ties the direct and significant connection analysis to the crude analysis in the final entities rule. I voted against the final entities rule for several reasons, including its flawed reasoning. I expressed my support, however, with respect to the positive outcome that resulted from the establishment of the $8 billion de minimis threshold.
8 See section V of the Proposed Guidance at ___ Fed. Reg. ___ (to be published in the Federal Register) (“In light of the significant extent of U.S. persons’ swap activities outside of the United States in today’s global marketplace, and the risks to U.S. persons and the financial system presented by such swaps activities outside of the United States with U.S. persons as counterparties, the Commission believes that U.S. persons’ swap activities outside the United States have the requisite connection with or effect on U.S. commerce under section 2(i) to apply the swaps provisions of the CEA to such activities.”). In a footnote in the Proposed Guidance, the Commission then reasons without persuasive legal support that the aggregate of outside activities and the aggregate connection with U.S. commerce warrant the application of the CEA swaps provisions to all such foreign activities.
The Commission’s analysis ignores and minimizes two important points. First, it ignores the fact that multinational entities also may have major operations and business relationships in foreign jurisdictions and may be considered persons within those jurisdictions. Second, its analysis minimizes the fact that there are an appreciable number of U.S. persons who engage in a relatively small number of swaps transactions. Even if those U.S. persons’ transactions were aggregated, it is questionable whether their swaps in the aggregate would meet the “significant” element in the section 2(i) analysis.
9 See section III.D.1 of the Proposed Guidance at ___ Fed. Reg. ___ (to be published in the Federal Register) (“To be eligible for this exception, the aggregate notional value (expressed in U.S. dollars and measured on a quarterly basis) of the swaps of all foreign branches in such countries may not exceed five percent of the aggregate notional value (expressed in U.S. dollars and measure on a quarterly basis) of all of the swaps of the U.S. swap dealer.”).
10 See, e.g., the MSP discussion in section II.C.2. of the Proposed Guidance at ____ Fed. Reg. ____ (to be published in the Federal Register).
11 The Proposed Guidance correctly cites judicial and executive branch precedent and guidance addressing the application of international law and comity concepts in determining the extraterritorial applicability of federal statutes. See section III.A. of the Proposed Guidance at ___ Fed. Reg. ___ (to be published in the Federal Register). These concepts are found in sections 403(1) and (2) of the Third Restatement of Foreign Relations Law. See Restatement (Third) of Foreign Relations Law of the United States §§ 403(1), 403(2) (1986).
12 See Capital Requirements of Swap Dealers and Major Swap Participants, 76 Fed. Reg. 27802 (May 12, 2011).
13 On June 18-19, 2012, the leaders of the G20 convened in Los Cabos, Mexico to reaffirm their commitments with respect to the regulation of the over-the-counter (“OTC”) derivatives markets. Specifically, the G20 leaders reaffirmed their commitment that all standardized OTC derivatives be traded on exchanges or electronic platforms and be centrally cleared by the end 2012. See the G20 Declaration (June 2012), para. 39, p. 7, at: http://www.g20.org/images/stories/docs/g20/conclu/G20_Leaders_Declaration_2012.pdf.
The Commission should follow the spirit of the G20’s cooperative efforts by working with foreign regulators to determine the applicability of its swaps regulations to cross-border swaps.
14 See statement by Commissioner Michel Barnier of the European Union, Financial Times, June 22, 2012 (“Where the rules of another country are comparable and consistent with the objectives of US law, it is reasonable to expect US authorities to rely on those rules and recognise activities regulated under them as compliant. We in the EU can do exactly the same . . . This is reasonable because it accepts legal boundaries and the need for regulators to trust and rely on each other. It is effective because it achieves our common objective of mandatory clearing, trading and reporting of OTC derivatives: no trade will escape the regulation. It is efficient because it avoids subjecting the same trades and businesses to two different sets of rules simultaneously and expensively.”).
15 Some jurisdictions have provisions that are similar to CEA section 2(i). For example, Article 13 of European Market Infrastructure Regulation (“EMIR”) provides that the European Securities and Markets Authority must prescribe technical standards specifying the contracts that are considered to have a direct, substantial and foreseeable effect on the European Union, or in cases where it is necessary or appropriate to prevent the evasion of any general applicability provisions in EMIR. See Regulation of the European Parliament and of the Council on OTC Derivatives, Central Counterparties and Trade Repositories, European Market Infrastructure Regulation (Mar. 29. 2012), available at: http://ec.europa.eu/internal_market/financial-markets/derivatives/index_en.htm. The Commission’s overreaching interpretation of CEA section 2(i) may inspire ESMA and other regulators to interpret their provisions in a similar manner.
16 See Statement of General Policy on the Sequencing of the Compliance Dates for Final Rules Applicable to Security-Based Swaps Adopted Pursuant to the Securities Exchange Act of 1934 and the Dodd-Frank Wall Street Reform and Consumer Protection Act, to be published under 17 C.F.R. Part 240 (June 11, 2012), available at: http://www.sec.gov/rules/policy/2012/34-67177.pdf.
17 Section IV.A.2 of the Proposed Guidance at ____ Fed. Reg. ____ (to be published in the Federal Register).
18 See Registration of Swap Dealers and Major Swap Participants, 77 Fed. Reg. 2613 (Jan. 19, 2012).
19 See 5 U.S.C. 551 et seq.
20 Under the Proposed Order, U.S. swap dealers and MSPs will only be required to register with the Commission and to meet the requirements under parts 20 (large swap trader reporting) and 45 (swap data recordkeeping and reporting) until December 31, 2012 before other entity-level requirements will become effective.
Last Updated: June 29, 2012