Sen. Carl Levin, Chairman of the Permanent Subcommittee on Investigations, filed a letter yesterday urging the CFTC to apply U.S. derivatives safeguards to London and other non-U.S. offices of U.S. financial firms. The key paragraph of Senator Levin’s letter is as follows:
In particular, this letter recommends: (1) applying derivative safeguards to U.S. financial institutions and their foreign branches and agencies on an entity-wide basis; (2) applying the same derivative safeguards to foreign affiliates and subsidiaries that are under common control with a U.S. financial institution; (3) rejecting suggestions to exempt derivatives trading conducted between the non-U.S. offices of U.S.-based financial institutions; (4) expanding the description of guarantee arrangements considered relevant to determining whether a foreign affiliate or subsidiary should be treated as a U.S. person to include, at a minimum, arrangements involving total return swaps, credit default swaps, and customized options; and (5) ensuring that the foreign offices of U.S.-based financial institutions, when conducting derivatives trades that have a direct connection to the United States, comply with the same capital, clearing, margin, recordkeeping, and reporting safeguards and business standards that apply to their U.S.-located counterparts.
Lofchie Comment: If the U.S. rules relating to swaps were economically rational and would produce a more creditworthy system, there would be considerable logic in transporting them offshore. However, if one believes that the U.S. swaps rules are not well considered (as evidenced by the mass migration of customers from swaps to futures (“futurization”) to avoid the burdens of Dodd-Frank), it logically follows that following Senator Levin’s suggestion should produce a collapse of the swaps business done by U.S. financial institutions outside the United States.
I use the word collapse rather than the word damage, because the reaction to non-economic rules in a competitive market should be swift. If the U.S. swaps rules are not attractive to non-U.S. customers, they won’t buy U.S. swaps. Financial markets move quickly on bad news and bad prices; that is why we have bank runs and flash crashes.
The counter to my belief that this proposal would severely damage U.S. financial institutions is the argument that the new swap rules make the U.S. markets better. If this were perceived to be the case by market participants, then non-U.S. market participants should be moving into the U.S. markets. My perception is that they are moving away. This perception can be empirically tested, in light of the information that the government has readily available, and by conducting a survey of the views of non-U.S. market participants. I hope that the regulators will carefully consider empirical data before pursuing actions that could put the offshore businesses of U.S. financial institutions at material risk.
See link to Senator Levin’s letter here.