July 12, 2013
Several weeks ago in London, as the commission intensified discussions on a number of cross-border issues, I spoke about three key objectives that must be achieved in a workable cross-border framework.
First and foremost, I said that the commission’s cross-border policy must protect U.S. taxpayers and the stability of the U.S. financial system.
Second, I said it must embrace a substituted-compliance approach that supports an efficient and sound derivatives-market structure while also ensuring a level competitive landscape for the firms operating within it.
And finally, I said the cross-border guidance must be clear and workable.
I am confident that the guidance and exemptive order before us today will adequately meet these objectives. I am therefore prepared to support them.
Protecting the U.S. Financial System and Taxpayers
Risk associated with derivatives is mobile and can migrate rapidly across borders in modern financial markets. All of us have observed that while financial activities abroad may be confined to local markets, the rights and responsibilities that flow from these activities often are not.
In light of this fact and in reaction to the financial crisis, Congress authorized the Commission to oversee activities conducted beyond U.S. borders in appropriate cases. Congress was purposefully less clear about what the appropriate cases might be, leaving it instead to this commission to make those judgments.
The guidance makes rational policy judgments about what those appropriate cases are today. The foreign branches of U.S. banks operating overseas, and other foreign entities benefiting from the credit support of a U.S. firm, will be required to register if they are active dealers in the swap markets. With registration, of course, the public is assured that such entities implement risk-management programs, report their swap activities, abide by capital standards, and manage credit risk in compliance with margin and clearing requirements.
I noted in London that it is paramount that the commission seek to achieve its regulatory objectives in a manner that respects the limits of U.S. law and the resource constraints of U.S. and global regulators. I acknowledged then, and I acknowledge now, that the commission must tread carefully with respect to activities occurring solely on foreign soil, especially those involving only foreign firms or foreign affiliates of U.S. firms.
I am persuaded, however, that the swap activities of foreign affiliates benefiting from the financial support of a U.S. guarantor, in the aggregate, do carry the potential to directly and significantly affect the health of the U.S. financial system. In many credit arrangements, risk flows directly back to the U.S. firm providing the guarantee. I think it appropriate for the commission to seek to contain the risks associated with swap dealing where that activity occurs.
In many cases, the guarantor itself is prudentially regulated. That might argue in favor of simply applying additional risk regulation to that entity. Prudential regulation, though, has taken into account risk importation issues for decades. It alone has not always prevented risk-management failures and the resulting threats to the stability of the financial system.
The guidance therefore brings guaranteed affiliates within the Dodd-Frank regime. It also takes the practical approach of allowing that non-U.S. affiliate to abide by risk-management practices required by the jurisdiction in which it is located, so long as the commission deems those practices comparable to U.S. law and sufficiently comprehensive. This approach strikes an appropriate balance between asserting the commission’s regulatory interest and recognizing the interests of other regulators.
An Efficient Market Structure without Competitive Disadvantages For One Legal Structure Over Another
The swap markets, as we all know, are global. The guidance therefore supports an efficient and sound market structure by permitting U.S. persons to trade and clear swaps with non-U.S. persons through markets and clearinghouses outside the U.S., so long as they are regulated in a manner that is “essentially identical” to Dodd-Frank.
This enormously consequential policy adjustment translates to open, competitive derivatives markets. It will mean efficient and liquid markets.
A global regime such as the one now contemplated in the guidance is the best means to avoid balkanization of risk and risk management that would have benefited no one. In fact, the fragmentation and regionalization of markets that I believe likely would have developed under the earlier proposals also would have exposed the U.S. financial system to risks that are unnecessary, needlessly complex, and difficult to predict and contain.
I want to thank Chairman Gensler for his flexible thinking on this particular topic during the past several weeks. Indeed, perhaps more than any other policy decision in this guidance, the commission’s resolution of this important policy issue best explains the accord we just reached with the Europeans on the cross-border regulation of derivatives.
There are two technical points I would like to mention, however. First, while I support the practical outcomes of the no-action letters that allow Eurex and LCH SA to clear U.S. dealer swaps pending completion of their applications to register with the commission, I believe this relief should have been delivered through formal commission action. Likewise, the no-action letter that finds the various risk-mitigation requirements under EMIR to be “essentially identical” should have been a commission action. In the future, I expect these determinations will receive the full input of the commission and legal force of a commission action.
Second, while for now we are requiring the European clearinghouses or foreign boards of trade to register with the commission, the final guidance contemplates a mutual recognition framework in which trading and clearing venues may compete fairly for U.S. business if they operate under “essentially identical” regimes.
For instance, in the European Union, it is expected that European law will soon provide for the registration of new trading venues, called organized trading facilities. The commission will have the flexibility under the guidance to examine the requirements applicable to these new platforms and determine whether they are “essentially identical” to U.S. law and therefore suitable for U.S. participants. Similarly, the guidance clarifies that such trading venues may register as swap execution facilities or petition for recognition as exempt SEFs.
Toward this end, the commission should undertake a rulemaking soon to implement a petition process for regulated trading venues abroad that might seek recognition as exempt SEFs. The commission’s staff is in fact developing a rulemaking to govern the process for recognizing exempt DCOs.
In addition to providing for an efficient market structure, the guidance avoids creating unfair advantages for certain firms over others, or for certain legacy business structures over others. The guidance now reflects the policy that if the activities of, and risks presented by, firms or business structures are not materially different, the commission will not treat such firms or business structures differently. Foreign branches and guaranteed affiliates that are registered dealers will abide by the same policies under the same circumstances.
The Guidance is Sufficiently Clear and the Exemptive Order Provides a Workable Compliance Timeline
For markets to operate efficiently, competitively, transparently, and safely, market participants must know whether U.S. law applies, whether U.S. law conflicts with the laws of foreign jurisdictions, and whether they are doing what the law requires. Based on the commission’s joint statement with the European Union yesterday, together with the commission’s documents today, market participants now should have a good understanding of the rules of the road for conducting swap activities on our two continents, which continue to host the vast majority of swap activity globally.
Although some called for more time, the Commission was not in a good position to delay these policy judgments any longer. Global market participants deserve regulatory certainty and today’s guidance and exemptive order provide it.
This week’s accord with our friends and partners in Europe, moreover, empowered the commission to adopt this policy even before the important work of delivering on the G-20 commitments was complete on that continent.
Inevitably, there will be questions arising from the guidance and exemptive order and perhaps issues unaddressed in these documents that should have been. But I am convinced that in sum, the most important questions have been answered clearly enough for now.
Finally, and based on today’s facts and circumstances, the exemptive order provides sufficient adjustment time for the marketplace, and appropriate incentives for foreign regulators to bring their regimes in line with Dodd-Frank. It could turn out that these compliance dates are too aggressive with respect to certain requirements. In that case, the commission must listen and respond to market participants and other regulators who bring legitimate compliance challenges to its attention.
Again, I want to thank the chairman for his flexibility and tireless work over the last several weeks. It was only a short while ago that I publicly expressed skepticism that the commission would be able to finalize these documents today. The commission was able to pull off this impressive feat, under a relatively truncated timeline, only because of his leadership and consensus-building.
And I want to thank the commission’s professional staff, who have worked day and night to bring the guidance and exemptive order over the finish line today. I appreciate your efforts, and the American public owes you a debt of gratitude for the important service you have provided that is now reflected in these important policies.
Last Updated: July 12, 2013