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CFTC cross-border recommendations
Chairman outlines CFTC regulations recommendations in white paper
Chairman Giancarlo, calling for a reset in cross-border regulatory relations, provides recommendations for how regulators can alter their cross-border approach in order to support a global, liquid, transparent swaps market.
October 19, 2018 | Financial services
Potential changes to cross-border swaps reform: CFTC Chairman Giancarlo outlines recommendations in white paper
Commodities and Futures Trading Commission (CFTC) Chairman J. Christopher Giancarlo released a white paper titled “Cross-Border Swaps Regulation Version 2.0: A Risk-Based Approach with Deference to Comparable Non-US Regulation”1 which recognizes that the 2013 CFTC cross-border guidance2 and 2016 proposed cross-border rules3 imposing transaction rules on swaps traded by the United States and non-US persons was an overextension of its jurisdiction. Chairman Giancarlo, calling for a reset in cross-border regulatory relations, provides recommendations for how regulators can alter their cross-border approach in order to support a global, liquid, transparent swaps market that fully lives up to the G-20 reforms and stays true to the spirit of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Commencing with the 2009 G-20 Summit in Pittsburgh, Pennsylvania, the CFTC and other global regulators have transformed the over-the-counter derivatives market through several reforms including improved trade reporting, central clearing, and margin and capital requirements for non-centrally cleared derivatives.4 However, the cross-border guidance implemented by the CFTC had the unintended consequence of overlapping and supplanting its international regulatory peers, thereby fragmenting global markets into a series of separate liquidity pools that increased systemic risk instead of diminishing it.
Principles guiding the white paper’s recommendations
Chairman Giancarlo’s proposal to update and improve the CFTC’s cross-border swaps framework is based on the limitations of the CFTC’s global reach as defined in Section 2(i) of the Commodity Exchange Act (CEA)5 and the uniqueness of the swaps market as an institutional market.6 The white paper recommends that new cross-border rules be based on the following principles:
Global standards for systemic risk: The CFTC should ensure that its reforms, designed to mitigate systemic risk across borders, are compatible with global standards and the laws of the G-20 regulators.
Stipulate the need for regulatory deference through having one regulator with one set of trading rules per jurisdiction: The CFTC and global regulators should commit to cross-border regulatory deference to allow market participants to operate under one set of rules per jurisdiction. The CFTC’s rules should not conflict with overseas regulatory frameworks, or contribute to the fragmentation of the global marketplace into global and domestic liquidity pools.
Encourage reform adoption: The CFTC and G-20 regulators should encourage overseas markets to implement swaps reform to reduce systemic risk and avoid creating safe-havens that aren’t in line with regulatory standards.
The white paper divides the swaps market into three parts: (1) the United States; (2) comparable jurisdictions; and (3) non-comparable jurisdictions. The white paper includes the following recommendations:
- Exemption for non-US central counterparties (CCPs) that pose no substantial risk to the US financial system:
- United States: The CFTC should continue to require US-based CCPs to register with the CFTC as a derivatives clearing organization (DCO). In addition, the financial stability oversight Council (FSOC) can designate financial market utilities (FMUs), including DCOs, as systemically important.
- Comparable jurisdictions: The CFTC should allow non-US CCPs access to the US financial system and US customers if the CCP poses no substantial risk and is comparably regulated in its home country. This change would allow non-US CCPs to clear with US customers without having to register as a DCO or futures commission merchant (FCM) with the CFTC. Non-US CCPs who do pose a risk to the financial system will still be required to register with, and be regulated by, the CFTC.
- Non-comparable jurisdictions: While non-US jurisdictions improve their standards, the CFTC should exempt non-US CCPs whose members are foreign branches of US banks (foreign branches) that are registered as swaps dealers from registering as a DCO, provided that these foreign branches “limit their clearing activities to proprietary and affiliate accounts that are non-US persons.” Foreign branches would find relief, as clearing transactions through a CCP that is a “qualifying central counterparty” (QCCP) afford the branch a more favorable capital treatment. This arrangement would require a memorandum of understanding between the CFTC and the non-US jurisdiction.
- Exemption for non-US trading venues:
- United States: The CFTC should continue to require swaps trading venues located in the United States as swap execution facilities (SEFs).
- Comparable jurisdictions: The CFTC should exempt non-US trading venues in comparable jurisdictions from registering as SEFs. This would permit these non-US trading venues to have US participants. Because the CFTC’s current trade execution requirement does not address systemic risk concerns, this change would reduce regulatory overlap for each trading jurisdiction.
- Non-comparable jurisdictions: The CFTC should require all trading venues in non-comparable jurisdictions to register as a SEF or as a derivatives contract market (DCM) if they provide US persons access to the trading venue directly or indirectly through a non-US intermediary.
- Re-categorizing parties subject to the de-minimis threshold:
- United States: The CFTC should continue to require US persons to count all of the swaps dealing transactions toward the $8 billion de minimis threshold, including transactions conducted through a foreign branch, regardless of the nationality of the counterparty.
- Comparable jurisdictions: Guaranteed entities, which the CFTC defines as having swaps guaranteed by a US person, should be required to have all swaps dealing activity count toward the de minimis threshold.
Foreign consolidated subsidiaries (non-US persons whose operating results, financial position, and cash flows are in accordance with the US Generally Accepting Accounting Principles (US GAAP)) and other non-US persons (non-US persons who are neither guaranteed entities or foreign consolidated subsidiaries) should be required to count swap dealing activity with US persons and guaranteed entities, except swaps with: (1) Guaranteed entities that are registered as or affiliated with swaps dealers; (2) guaranteed entities that are guaranteed by a non-financial guarantor; or (3) foreign branches that are registered as swaps dealers.
Guaranteed entities, foreign consolidated subsidiaries, and other non-US persons should be able to rely on the substituted compliance of the home country regulator.
- Non-comparable jurisdictions: Guaranteed entities should continue to count their entire swap dealing activity toward the de minimis threshold, regardless of the nationality of their counterparties.
Other non-US persons should be required to count swap dealing activity with US persons and guaranteed entities, except swaps with: (1) Guaranteed entities that are registered as or affiliated with swaps dealers; (2) guaranteed entities that are guaranteed by a non-financial guarantor; or (3) foreign branches that are registered as swaps dealers.
Foreign consolidated subsidiaries will have to be analyzed specifically for their “direct and significant” connection to the US financial system.
- Clearing and trade execution requirements
- United States: US persons (including foreign branches) should continue to be subject to the CFTC’s swaps clearing and trade execution requirements for all applicable swaps (50.4 Swaps7), unless an exception or exemption applies. A US person entering a swap subject to the trade execution requirement must continue to trade the swap on a DCM or a registered or exempt SEF.
- Comparable jurisdictions: Non-US persons, including guaranteed entities and foreign consolidated subsidiaries, should be eligible to rely on substituted compliance granted by the CFTC. However, market participants should expect the CFTC to apply stricter comparability on clearing requirements than trading requirements, as clearing requirements are focused on systemic risk.
- Non-comparable jurisdictions: The CFTC’s swap clearing requirement should apply to all 50.4 swaps of foreign branches, subject to a materiality threshold for swaps with other non-US persons in non-comparable jurisdictions.
For guaranteed entities, the CFTC’s clearing requirement would apply to all 50.4 swaps between guaranteed entities and: (1) US persons, including foreign branches; (2) guaranteed entities; and (3) Other non-US persons unless the swaps are subject to initial and variation margin requirements for uncleared swaps consistent with standards established by the Basel Committee on Banking Supervision and International Organization of Securities Commission Working Group on Margining Requirements (WGMR).
For other non-US persons, the clearing requirement should apply to all 50.4 swaps with (1) US persons, including foreign branches; and (2) guaranteed entities, unless the swaps are subject to WGMR.
- Exempting ANE Transactions from the de minimis threshold
The white paper recommends that the CFTC apply its clearing and trade execution requirements to any swap that is executed in the United States by any personnel or agent of a non-US person located in the United States. This would require any swap of this kind to be traded on a SEF and centrally cleared to consolidate the liquidity of the US market.
In addition, the white paper recommends that swaps “arranged, negotiated, and executed” in the United States by a non-US person do not count toward a non-US dealer’s de minimis threshold if the non-US dealer is in a comparable jurisdiction, as these transactions do not pose a systemic risk.
Chairman Giancarlo encouraged international regulators and policymakers to join him in pursuing regulatory deference, as overlapping and confounding cross-border regulation has a high regulatory cost and puts constraints on economic growth. Chairman Giancarlo intends to direct the CFTC to develop and publish new rules. The resulting rulemakings would replace the cross-border guidance issued by the CFTC in 2013 and the cross-border rules proposed by the CFTC in 2016, as well as address certain positions taken in CFTC staff advisories and no-action letters.
However, Chairman Giancarlo is not seeking reappointment when his term ends in April 2019. As a result, any rules resulting from the reforms outlined in the white paper, especially those requiring cooperation between domestic and international agencies, will likely require buy-in from the next CFTC chair.
As further developments occur, Deloitte will issue additional updates as appropriate.
1 Commodities and Futures Trading Commission (CFTC). 2018. Cross-Border Swaps Regulation Version 2.0: A Risk-Based Approach with Deference to Comparable Non-US Regulation
2 CFTC. 2013. Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations.https://www.cftc.gov/sites/default/files/idc/groups/public/@lrfederalregister/documents/file/2013-17958a.pdf
3 CFTC. 2016. Cross-Border Application of the Registration Thresholds and External Business Conduct Standards Applicable to Swap Dealers and Major Swap Participants.
and CFTC. 2016. Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants—Cross-Border Application of the Margin Requirements.
4 US Treasury. 2009. Leaders’ Statement – The Pittsburgh Summit
5 Government Printing Office (GPO). 2011. 7 U.S.C. 2 – Jurisdiction of Commission; Liability of Principal for Act of Agent; Commodity Futures Trading Commission; Transaction in Interstate Commerce.
6 Section 2(e) of the CEA provides that “it shall be unlawful for any person, other than an eligible contract participant [i.e., non-retail], to enter into a swap unless the swap is entered into on, or subject to the rules of, a board of trade designated as a contract market.” 7 U.S.C. § 2(e).
7 Government Printing Office (GPO). 2014. 17 CFR 50.4 – Classes of Swaps required to be cleared.
James H. Caldwell
This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.
Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.
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