ISDA, SIFMA, and the Institute of International Bankers (“IIB”) (the “Associations”) have filed a joint legal challenge to the CFTC Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations (“Cross-Border Rule”) and related cross-border rules.
The lawsuit alleges that the CFTC unlawfully circumvented the requirements of the Administrative Procedures Act and the CEA by portraying its regulations as “guidance.” By circumventing the rulemaking process, including failing to conduct a cost-benefit analysis required by law, that the CFTC has enacted rules which the Associations believe are duplicative, overlapping and contradictory. According to the Associations, this “overreach could cause global fragmentation in markets,” which could reduce liquidity and significantly harm market participants and market-based financing. Additionally, the lawsuit alleges that by not conducting any cost-benefit analysis as required by law, the cross-border rules create significant administrative, financial, and legal burdens that could negatively affect liquidity and the ability of end users to manage risk.
Furthermore, the Associations argue, there is global consensus among regulators regarding the regulatory reform initiatives in OTC derivatives. The joint CFTC-EU statement, “Path Forward,” affirms that all rules must not overlap or duplicate one another in order to avoid conflicts of law. The Associations cite an example in which a non-U.S. swap dealer that is transacting with a non-U.S. customer could be required to comply with the CFTC’s transaction-level requirements if the dealer’s U.S. office assists in the transaction. This would mean that the same trade would be required to be cleared at both a U.S. and non-U.S. clearinghouse. The Associations believe that the CFTC’s cross-border guidance and subsequent interpretations undermine the global commitment to prevent contradictory, overlapping and duplicative requirements, which has led non-U.S. counterparties to avoid transacting with U.S. dealers and non-U.S. dealers based in the U.S.
Lofchie Comment: From the day on which the CFTC Cross-Border Guidance was issued, I have said that I believed that (i) the CFTC’s Cross-Border Guidance was issued in violation of law and (ii) the CFTC was not likely in the long run to achieve anything from such violation. See, e.g., CFTC Approves Cross-Border Guidance and Exemptive Order (July 15, 2013). That belief will now play itself out as predicted.
One of two things may happen now. First, the CFTC may lose this case, which I believe it should. Second, the CFTC may win this case (if some judge grants the CFTC an extraordinary measure of regulatory deference) on the ground that the CFTC’s “guidance” is, as the CFTC sometimes asserts, just guidance – not enforceable as a rule – in which case the CFTC is left with “guidance” that (beyond being ill-advised as a matter of substance) has little legal effect because the supposed “guidance” (not being a legally-adopted rule) cannot serve as the basis for an enforcement action.
Further, the CFTC’s difficulties go beyond this legal challenge to the cross-border guidance. If the position limits rule is adopted in its present form, there is the very likely possibility of a further challenge to that rule given, what seems to be a very strong argument, that the rule is not properly supported by either academic foundation or cost-benefit analysis. While the CFTC has touted itself as being ahead of other regulatory agencies in adopting rules to implement Dodd-Frank, that lead has been achieved by adopting rules in disregard of the comments of market participants (both buy and sell-side) and of other regulators, sometimes on the basis of cost-benefit analyses that seem implausible on their face. The result has been the adoption of rules that are, at best, enormously expensive to implement, and sometimes wholly impossible to implement. That would be bad enough, but, worse still, as we have often commented, we believe that many of the rules will both increase systemic risk and damage the economy.
When the new Chairman of the CFTC is appointed, that person is likely to find that the CFTC’s lead in rule adoption is illusory – a Potemkin village build without any foundation on either economic policy or legal process.