SEC Chairman Elisse Walter delivered remarks at the American Bar Association Spring Meeting in Washington, D.C., discussing her approach to the cross-border regulation of derivatives.
Chairman Walter posited that there were four potential approaches that the SEC could take to the cross-border regulation of swaps. First, the SEC could simply allow non-U.S. swap dealers to do business in the United States only subject to their own home country legal requirements. Second, the SEC could subject non-U.S. swap dealers to the full body of U.S. regulation. Third, the SEC could allow non-U.S. swap dealers to do business in the United States only if their local rules were deemed to be fully comparable to U.S. rules. Fourth, the SEC could allow non-U.S. swap dealers to do business in the United States subject to home country rules to the extent the SEC deemed those rules sufficient, and subject to the SEC’s rules where the SEC believed that there was a home country gap.
Chairman Walter endorsed the fourth approach and explained her practical considerations in so doing. She also made clear that the fourth approach, which she called “substituted compliance,” differered very substantially from the CFTC’s original use of the term, in that she did not anticipate a rule-by-rule review, but rather a broader overview of rules of a certain type. She also expected that the SEC would take into consideration the way that rules were enforced, in particular jurisdictions, in addition to the way in which they are written.
Chairman Walter has established a reasonably practical direction for the SEC to take in establishing the direction of cross-border swaps regulation. (I also note that Chairman Walter’s tenure in that position is limited, as Mary Jo White’s nomination as Chairman was approved today by the Senate. Assuming that new Chairman White agrees with Chairman Walter’s views, then. . . .)
One question will be whether the CFTC will fall in with the SEC or continue to assert a much more expansive view of its own authority over non-U.S. swap dealers. It is likely that the CFTC will fall in line with the SEC (it has already been making a quiet retreat in that direction) because (i) it is fundamentally not workable for the CFTC and the SEC to regulate the same issue in completely opposing manners and (ii) the CFTC’s approach is not acceptable to non-U.S. regulators for the reasons set out in Chairman Walter’s speech. That said, Chairman Walter’s direction will not be easy to implement; it will require U.S. regulators (who are already overburdened) to attempt to compare, on an ongoing basis, the U.S. regulation of swaps with their regulation in other jurisdictions, and then to adopt rules to fill in the gaps where the swap dealer rules in some other jurisdiction are deemed to fall short. I am not aware of any model for the financial regulators attempting to regulate in this manner, so the SEC will be charting a novel course.
For non-U.S. financial firms, what this means is that they should be gearing up to educate their home country regulators to make the argument to the SEC and the CFTC that their home country rules are sufficient, and require little or no supplement from the U.S. regulators. Of course, non-U.S. financial firms can make these arguments directly to the U.S. regulators, but the arguments will be made far more effectively if they are advanced by home country regulators.
For U.S. financial firms (and non-U.S. ones as well), they must give consideration as to how to structure their businesses globally. Dodd-Frank imposes material and needless burdens on both swap dealers and swap customers. U.S.-based swap dealers will have to consider whether they can compete to do business with non-U.S. customers unless they operate out of a separate non-U.S. entity. There is growing concern is that U.S.-based swap dealers effectively will be required to move their non-U.S. swap activities abroad in order to be competitive. Certainly, all firms should be considering where business can be best conducted and, in this regard, should be planning how to hire personnel and build systems where it makes sense to do so. Big picture: we seem to be moving toward a regulatory culture where it will be advantageous to establish booking entities in numerous jurisdictions and do business with local customers, rather than to establish global booking entities.