University of Houston finance professor Craig Pirrong posted on his blog commentary discussing the ongoing conflict between the United States and EU regarding derivatives regulatory policy, and the consequences of the United States and EU not accepting each others clearing rules as equivalent.

According to Mr. Pirrong, this issue is particularly pressing due to the upcoming December 2014 deadline for the EU to recognize U.S. central counterparty clearing houses (“CCPs”) as equivalent. Mr. Pirrong stated that if this does not happen, European banks that use a U.S. CCP will face a substantially increased capital charge on the cleared positions.

Mr. Pirrong further explained that this “game of chicken going on between the EU and U.S.” could lead to the world derivatives market becoming more fragmented, and therefore less competitive – an outcome that is “cruelly ironic,” according to Mr. Pirrong, given that previous CFTC Chairman Gary Gensler claimed his regulatory agenda would make the markets more competitive. Mr. Pirrong went on to note that EU Commissioner Michel Barnier’s recent statement approving the CCPs of five countries outside the EU, but not the United States, can be read as “a giant one finger salute from the EU to the CFTC.”

Mr. Pirrong concluded that the United States and EU are “fighting over control,” and the outcome will be a more fragmented, less competitive, and less robust financial system.

Lofchie Comment: In his usual impolitic style, Professor Pirrong makes the point that the CFTC’s drive for more global regulatory power is meeting the countervailing force of non-U.S. regulators who see no reason to defer to the CFTC. The CFTC would seem not likely to persuade the European financial regulators to concede, since it is hard to imagine their motive to concede authority over European firms to the CFTC. Accordingly, the CFTC has put itself in the position where it must either retreat (the rational thing to do) or do further damage to the U.S. economy by essentially conceding that the world is going divide up into economic zones, with the end result both a smaller world economy and one in which the role of U.S. financial institutions is confined to the U.S. zone.

More generally, certain of the U.S. regulators seemed to be of the view that they can increase the scope and demands of U.S. regulation without any reaction from either other regulators or market participants. That is demonstrably not the case. If U.S. regulators assert global regulatory jurisdiction, non-U.S. regulators are going to push back.

See: “What Gary Gensler, the Igor of Frankendodd, Hath Wrought,” Streetwise Professor.
Related news: EU Commissioner Barnier to Accept Clearing Rules from Five Countries outside EU, but Not the United States (July 1, 2014).

EU Commissioner for Internal Market and Financial Services Michel Barnier said he intends to propose that the European Commission (“EC”) adopt “equivalence” decisions that will allow central counterparty clearing houses (“CCPs”) from five countries outside the European Union to clear EU derivatives trades. The allowed countries will be Japan, Singapore, Australia, Hong Kong and India.

Regarding the absence of the United States from the list, Commissioner Barnier noted that, if the CFTC gives effective equivalence to third-country CCPs, he is confident that the list will include the United States soon.

CFTC Commissioner Scott O’Malia wrote a letter to Commissioner Barnier on May 6, 2014, urging him to proceed with finding the U.S. regulatory regime equivalent under EMIR so that ESMA may recognize U.S. CCPs. Commissioner O’Malia stated that, although “there may be some nominal differences” between the regimes, the rules comply with the CPSS-IOSCO Principles for Financial Market Infrastructures and are “essentially identical as a result of the collaboration, coordination, and cooperation between the CFTC and EC.”

Lofchie Comment: Here are the key points in the Barnier statement:

“I intend to propose shortly that the European Commission adopt ‘equivalence’ decisions that will allow CCPs from five countries outside the EU – Japan, Singapore, Australia, Hong Kong and India – to clear EU derivatives trades.  This will be done in full deference to the rules and supervisory systems of those countries. . . . If the CFTC also gives effective equivalence to third country CCPs, deferring to strong and rigorous rules in jurisdictions such as the EU, we will be able to adopt equivalence decisions [recognizing U.S. clearing corporations] very soon.”

To put it more bluntly, the European Union has no intention of allowing the U.S. regulators to dictate how European regulators should regulate European financial institutions or financial conduct in Europe. 

Credit should be given to Commissioner O’Malia for reaching out to Commissioner Barnier and trying to avoid this result, but there is a history of contentiousness between the CFTC under former Chairman Gensler and the European Union. That history apparently resulted in the EU taking a “show me” approach, which could not be overcome by Commissioner O’Malia’s letter, as he does not speak as chairman of the agency. Commissioner Barnier’s response should be taken as a caution to those U.S. regulators who believe that they can dictate global regulation. Other regulators can and will push back. The potential danger of this dispute not being resolved is nothing short of a trade war. 

See: Commissioner Barnier’s Statement. 
See also: Commissioner O’Malia’s Letter.