In response to the June 23, 2014 order from the U.S. District Court for the District of Columbia (the “Court”), the CFTC, as well as SIFMA, ISDA and the Institute of International Bankers (the “Associations”), submitted supplemental briefs to the Court regarding (i) shareholder standing and (ii) interpretive rules in the lawsuit against the CFTC’s Cross-Border Guidance.  

According to the Associations’ supplemental brief, an association has standing to challenge government action “when at least one of its members has standing, the interests it seeks to protect are germane to the organization’s purpose, and the participation of its individual members in the suit is not otherwise required.”  The Associations stated that they have standing in the Cross-Border Guidance Case, and that they can challenge the CFTC Cross-Border Rule because “their formally enrolled members and their represented affiliates could do so individually.”

By contrast, the CFTC’s supplemental brief asserted that, when the Associations disclosed the names of members allegedly injured by the Cross-Border Guidance after originally claiming that standing was “self-evident,” the employees came from two types of entities: (i) U.S.-based conglomerates, such as JPMorgan, Goldman Sachs and Morgan Stanley; and (ii) conglomerates based overseas, such as Société Générale and Deutsche Bank.  The CFTC asserted that none of the relationships of the employees in these entities conferred standing.

Furthermore, the Associations’ supplemental brief explained, the Cross-Border Rule cannot be sustained as an interpretive rule because the CFTC labeled the Cross-Border Rule as a policy statement and it is plainly legislative rather than interpretative.  According to the Associations, it is “absurd for the CFTC to contend that regulated entities will not consider themselves bound by interpretations that – in enforcement actions – federal courts will feel obligated to apply.”  The Associations went on to say that, in any event, “treating it as interpretive would not cure the CFTC’s procedural errors.”

In the CFTC supplemental brief, the CFTC explained that the Cross-Border Guidance is “best classified as a general statement of policy,” but that certain of its statements also could be classified as interpretive rules.  The CFTC stated that, regardless of classification, the Cross-Border Guidance is not final agency action or otherwise reviewable, and classifying it as interpretative would not change the conclusion that the cost-benefit requirement is inapplicable.

The CFTC also submitted a second notice of supplemental authority to bring to the Court’s attention the July 11, 2014 decision in National Mining Association v. McCarthy (“Decision”), during which the U.S. Court of Appeals for the District of Columbia Circuit reversed a decision that the Associations relied upon in their argument regarding the standard for distinguishing non-reviewable policy statements from reviewable legislative rules.  The CFTC stated that the analysis of this Decision strongly supports its position in the Cross-Border Guidance Case, since it reiterates that established law and general statements of policy are not subject to pre-enforcement judicial review under the Administrative Procedure Act.  Additionally, the CFTC stated that the Decision concludes that “the most important factor” in determining whether an agency action is a policy statement or legislative rule “concerns the legal effect (or lack thereof) of the agency action in question on regulated entities.”  The CFTC explained that the Associations have identified no legal effect of the Cross-Border Guidance.

Lofchie Comment:  Whatever one believes about the quality of the policy informing the CFTC’s Guidance, the process (or absence thereof) should be regarded as unacceptable.  Government agencies diminish the moral force of government regulation when they seem to circumvent the procedures by which government agencies are “required” to act.  Further, one cannot argue that the CFTC was “forced” into a procedural end-around by its inability to adopt rulemaking over the resistance of dissidents.  Given the rules of the CFTC, former Chair Gensler was part of the majority during his entire tenure at the CFTC and was entirely able to obtain the votes necessary to adopt his desired measures, but he should not have been able to do so without the checks afforded by public comment and cost-benefit analysis. 

See: The Associations Supplemental Brief; CFTC Supplemental Brief; CFTC Second Notice of Supplemental Authority.
See also: National Mining Association v. McCarthy.

The CFTC filed a motion to submit the supplemental declaration of CFTC Assistant General Counsel Martin B. White (the “declaration”) and two additional documents that, in the words of the CFTC, contradict “the positions SIFMA and other Plaintiffs have taken on key legal points in this case.”  Specifically, the two exhibits filed include (i) a document titled “Note Regarding Non-U.S. Affiliate Participation in Swaps Market” (“SIFMA’s Note”), and (ii) a copy of an article published by POLITICO Pro titled “Banks Outline Pushback on Swap Guarantee Worries.”

According to the declaration, SIFMA’s Note states that Congress “set standards” for cross-border swaps regulation, which contradicts the claims of SIFMA, ISDA and the Institution of International Bankers (“Associations”) in the Cross-Border Guidance case.  Additionally, the CFTC stated, SIFMA’s Note concedes that the Cross-Border Guidance is “guidance,” which differs from the Associations’ claim that the Cross-Border Guidance “is a rule in disguise that extends the Title VII Rules overseas.”  

The CFTC also claimed that the apparent purpose of SIFMA’s Note is to suggest to its members a public explanation for a new business practice, in which U.S. parents of overseas affiliates remove guarantees from swaps with foreign counterparties.  The CFTC stated that this indicates that the Associations’ claim to injury from the Cross-Border Guidance may not be true.

See: CFTC Motion to File Supplemental Declaration; Martin White’s Supplemental Declaration (with SIFMA Note and POLITICO Pro Article).
Related news: Court Requests Supplemental Briefs from Parties in SIFMA v. CFTC Cross-Border Guidance Case (June 25, 2014); SIFMA v. CFTC Cross-Border Guidance Case Reassigned to New Judge (June 23, 2014);  Judge Grants Amici Motion for Leave to File Brief in Support of CFTC; CFTC Submits Notice of Supplemental Authority in SIFMA v. CFTC Cross-Border Guidance Case (June 18, 2014); Congressional Democrats’ Amicus Brief Sides with CFTC in SIFMA v. CFTC (March 25, 2014); Better Markets Amicus Brief Supports CFTC’s Cross-Border Guidance (March 21, 2014); CFTC Legal Memorandum to Dismiss Challenge to Its Cross-Border Guidance (March 18, 2014); Chamber of Commerce Submits Amicus Brief Regarding Lawsuit against CFTC Cross-Border Rule (February 5, 2014); Market Participants File Amended Complaint Challenging CFTC Cross-Border Guidance (January 8, 2014); Market Participants File Lawsuit Challenging CFTC Cross-Border Guidance for Being a Rule Adopted in Violation of the APA (December 4, 2013).

The Managed Funds Association (“MFA”), SIFMA and ISDA sent separate comment letters to the European Supervisory Authorities (“ESAs”) on their joint consultation paper, titled “Draft Regulatory Technical Standards on Risk-Mitigation Techniques for OTC-Derivative Contracts Not Cleared by a CCP” (“Consultation Paper”), regarding EMIR (“European Market Infrastructure Regulation”).

The MFA’s letter voiced support for the ESAs’ efforts to reduce counterparty credit risk and mitigate the potential for systemic risk resulting from uncleared OTC derivative markets. The MFA emphasized the need to ensure that the final regulatory technical standards (“RTS”) outlined in the Consultation Paper are consistent with mandatory margin requirements in other jurisdictions.

Additionally, SIFMA and ISDA submitted a joint comment letter regarding the Consultation Paper. The letter identifies areas of the draft RTS where additional rulemaking and clarification is needed, focusing on subjects including:

• that the mandatory capture of main nonlinear dependencies and certain other model requirements are overly rigid and prescriptive;
• the restrictive nature of the proposed concentration limits;
• that an 8% FX haircut on mismatched collateral would create operational, credit and settlement risk;
• a two-year implementation window to comply with margin requirements; and
• consistent margin rules across major financial jurisdictions.

See: MFA Comment Letter; SIFMA-ISDA Comment Letter.

CFTC Commissioner O’Malia delivered the keynote address at the Quadrilateral Meeting of European and American financial regulators and lawyers. He focused on what he viewed as the problems created by CFTC rulemaking during the tenure of Chairman Gensler.

Commissioner O’Malia asserted that the fundamental principle for reform is that “regulators must do no harm.” He expressed his concern over continuing reports of market fragmentation and the fracturing of liquidity between U.S. and non-U.S. markets as a result of diverging regulatory approaches to the implementation of the G20 principles. In addition to market fragmentation, he said, the existing CFTC regulations are negatively impacting liquidity for end users and making hedging too costly, leading to high prices for commodities.

According to Commissioner O’Malia, effective regulation comes from a balance between protecting market participants and fostering transparent open, competitive and financially sound markets. He explained that the CFTC must reexamine rules that have negatively affected the market. One example he cited was the definition of “swap dealer.” According to Commissioner O’Malia, the CFTC “failed to faithfully interpret Dodd-Frank by broadly applying the swap dealer definition to all market participants and ignored the expressed statutory mandate to exclude end users from its reach.” Furthermore, Commissioner O’Malia stated, he supports the Customer Protection and End-User Relief Act (H.R. 4413) that was recently passed by the house, stating that it provides important market structure and CFTC reforms that recognize the “real problems” in the markets.

Commissioner O’Malia went on to explain that a holistic approach, which includes substituted compliance and mutual recognition, is essential to a successful cross-border regulatory policy. Commissioner O’Malia stated that he hopes the European Commission will continue to work with the CFTC to find the U.S. regulatory regime equivalent under the European Market Infrastructure Regulation so that the European Securities Market Authority may proceed with the recognition of U.S. central counterparty clearinghouses by the December 15, 2014 deadline under the Capital Requirements Directive (“CRD IV”). Commissioner O’Malia also identified international data sharing and harmonization as another area where mutual cooperation is critical.

Finally, Commissioner O’Malia touched on the technology problems that have plagued the CFTC. He explained that inadequate support for technology has left the CFTC with a “diminished automated surveillance capacity and an inability to manage the regulatory data stored in SDRs.” Commissioner O’Malia called on the CFTC to make serious data technology investments in order to establish automated surveillance as the foundation of the CFTC’s oversight and compliance program. 

Lofchie Comment: Consistent with Commissioner O’Malia’s “fundamental principle of reform” to do no harm, there should be a review of regulations (not only those adopted by the CFTC) that require the reporting of information which the relevant regulator has no ability to store or analyze. It would be useful if an impartial organization, such as the GAO, would conduct a study of the ability of the various financial regulators to make productive use of the various types of information they require to be delivered to them.

See: Commissioner O’Malia’s Speech.
Related news: House Votes to Reauthorize the CFTC, but with New Obligations as to Its Exercise of Authority (providing a description of HR 4413) (June 25, 2014).

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.

The U.S. District Court for the District of Columbia (the “Court”) requested supplemental briefs from SIFMA, ISDA, the Institution of International Bankers (“Associations”) and the CFTC regarding (i) shareholder standing and (ii) interpretive rules in the lawsuit against the CFTC’s Cross-Border Guidance. 

Specifically, the Court and newly assigned Judge Paul Friedman requested that the Associations and the CFTC submit no more than 12 pages in length addressing:

• whether the “shareholder standing” rule in the Cross-Border Guidance, which states that “[n]o shareholder – not even a sole shareholder – has standing in the usual case to bring suit . . . on a claim that belongs to the corporation,” is jurisdictional, prudential or a manifestation of the Federal Rules of Civil Procedure Rule 17(a)’s real-party-in-interest requirements.  The Court also asked what implications the shareholder standing rule had in this case regarding the elements of the CFTC’s Cross-Border Guidance that, if and when applied, “would seem to directly regulate the plaintiffs’ members’ legally distinct subsidiaries – but no member itself”; and
• whether the Cross-Border Guidance is an interpretive rule, based on the Court’s articulated standards for distinguishing interpretive rules from policy statements and legislative rules, and what the implications of an interpretive rule might be as to ripeness, cost-benefit requirements and the level of deference to be applied by the Court. 

The Court requested that both parties submit supplemental briefs addressing these issues by July 14, 2014. 

See: Request for Supplemental Briefs. 
Related news: SIFMA v. CFTC Cross-Border Guidance Case Reassigned to New Judge (June 23, 2014); Judge Grants Amici Motion for Leave to File Brief in Support of CFTC; CFTC Submits Notice of Supplemental Authority in SIFMA v. CFTC Cross-Border Guidance Case (June 18, 2014); Congressional Democrats’ Amicus Brief Sides with CFTC in SIFMA v. CFTC (March 25, 2014); Better Markets Amicus Brief Supports CFTC’s Cross-Border Guidance (March 21, 2014); CFTC Legal Memorandum to Dismiss Challenge to Its Cross-Border Guidance (March 18, 2014); Chamber of Commerce Submits Amicus Brief Regarding Lawsuit against CFTC Cross-Border Rule (February 5, 2014); Market Participants File Amended Complaint Challenging CFTC Cross-Border Guidance (January 8, 2014); Market Participants File Lawsuit Challenging CFTC Cross-Border Guidance for Being a Rule Adopted in Violation of the APA (December 4, 2013).