CFTC Commissioner Scott D. O’Malia delivered a speech to fellow CFTC Commissioners and international regulators thanking them for their work in modifying the Cross-Border Guidance and Exemptive Order. In his remarks, Commissioner O’Malia advocated his preference for engaging international regulators before the release of the Proposed Guidance instead of imposing statutorily weak guidance in haste. In addition, Commissioner O’Malia supported a 75-day comment period on the Exemptive Order in order to market participants to comply with the CFTC’s last-minute guidance. 

See: Commissioner O’Malia’s Opening Statement.

Commissioner Chilton commended the CFTC, saying “we’ve done way more than other financial regulators.”

Lofchie Comment:  I agree with Commissioner Chilton that the CFTC has done way more than other financial regulators.  However, financial regulators are better judged on the quality of their work than quantity.  In this regard, according to Commissioner Chilton, the CFTC may “leave a thread hanging loose.”  On this issue, we do not agree.  As I commented separately in regard to the CFTC’s action, the CFTC would have done better by the country in issuing a definitive proposal for public comment; had it done so, it would have received comments going beyond a loose thread.

See: Commissioner Chilton’s Statement.

Commissioner Wetjen explained how he was persuaded to support the CFTC’s Cross-Border Guidance and Exemptive Order.   As to the timing,  Commissioner Wetjen said (i) on the one hand, the CFTC “was not in a good position to delay these [cross-border] policy judgments any longer and (ii) on the other hand, “it could turn out that these compliance dates are too aggressive with respect to certain requirements,” and thus the CFTC should be prepared to issue delays.

Lofchie Comment:  On the issue of timing, the new requirements can not reasonably be achieved.  Thus, we re-experience this seemingly endless cycle of the CFTC bringing forth requirements with unrealistic compliance dates, and so no-action relief must be issued (often after the compliance date has passed), which restarts the cycle yet again.

See: Commissioner Wetjen’s Statement.

The CFTC released the attached documents just in advance of its scheduled meeting on cross-border issues.

See: Cross-Border Fact Sheet.
See also: Exemptive Order Fact Sheet.

The CFTC issued four no-action letters that address certain issues relating to swaps regulation, following the announcement earlier today by European Commissioner Barnier and CFTC Chairman Gensler of a “Path Forward” for how to jointly approach cross-border derivatives.

Two of the letters were issued by the CFTC’s Division of Clearing and Risk (“DCR”) to two European-based clearing organizations, respectively, intended to facilitate their provision of certain clearing services to clearing members that are U.S. persons, during the pendency of their derivatives clearing organization (“DCO”) registration applications. In the respective letters, DCR provided no-action relief as follows:

• DCR will not recommend that the CFTC take enforcement action against LCH.Clearnet SA (“LCH.C SA”) for failing to register as a DCO under CEA Section 5b(a) with respect to clearing certain credit default swaps on a broad-based index of reference entities (“Index CDS”).
  • In addition, DCR will not recommend enforcement action against U.S. clearing members of LCH.C SA for failing to clear their proprietary Index CDS business through a registered DCO.
• DCR will not recommend that the CFTC take enforcement action against Eurex Clearing AG (“Eurex Clearing”) for failing to register as a DCO under CEA Section 5b(a) with respect to clearing certain interest rate swaps (“IRS”) and certain Index CDS.
  
  • In addition, DCR will not recommend enforcement action against U.S. clearing members of Eurex Clearing for failing to clear their proprietary IRS and Index CDS business through a CFTC-registered DCO.

In each case, the relief will be effective until the earlier of (1) December 31, 2013, or (2) the date upon which the CFTC approves LCH.C SA’s or Eurex Clearing’s (as applicable) pending application for registration as a DCO.

A third no-action letter was issued by the CFTC’s Division of Swap Dealer and Intermediary Oversight (“DSIO”), providing relief from certain designated risk mitigation requirements applicable to registered swap dealers (“SDs”) and major swap participants (“MSPs”) organized or established in the United States or European Union with respect to certain transactions, when such transactions are subject to both CEA Section 4s and Article 11 of the European Market Infrastructure Regulation (“EMIR”). Under the terms of the no-action letter, DSIO stated that relief would be extended to SDs and MSPs for whom, under both regimes, the requirements are essentially identical and the SD or MSP complies with the requirements under EMIR. The scope of relief provided in the no-action letter is subject to the specific conditions that are enumerated in the letter, including its limitation to the products and participants described in the letter.

Finally, the CFTC’s Division of Market Oversight (“DMO”) issued a no-action letter that expands the relief previously provided under the terms of the 16 existing direct access no-action letters issued by CFTC staff. Pursuant to the previous no-action letters, a foreign board of trade (“FBOT”) may permit identified members or other participants located in the United States to enter trades directly into the trade matching system of the FBOT only with respect to futures and option contracts. Under the terms of the no-action letter issued today, DMO amended the previous no-action letters to permit those FBOTs to list swap contracts for trading by direct access, subject to certain conditions that are enumerated in the letter.

Lofchie Comment:  These no-action letters are being issued on the eve of the CFTC’s open meeting on cross-border issues.  To the extent that the issuance of these letters and the adoption of the “Path Forward” signals that the CFTC is going to adopt cross-border regulatory rules that have not been subject to public comment or review, that is unfortunate.

See: CFTC Letter 13-43; CFTC Letter 13-44; CFTC Letter 13-45; CFTC Letter 13-46.
See also: Attachment A-Products Offered for Clearing by Eurex Clearing AG.
Related News: The CFTC and the European Commission on Common “Path Forward” for Regulating Derivatives (July 11, 2013).

The CFTC has issued a press release stating that CFTC Chairman Gensler and EC Commissioner Barnier have reached agreement on a ”Path Forward” as to how to regulate cross-border derivatives.

The Path Forward is intended to cover matters such as the regulation of clearing corporations, swap execution facilities, trade reporting, trade execution requirements and the definition of ”US person.” In this regard, the Path Forward indicates that (i) offshore guaranteed affiliates of U.S. persons could be regarded as U.S. persons, but trades with them would be subject only to substituted compliance, (ii) that foreign branches of U.S. banks could satisfy U.S. requirements by means of substituted compliance and (iii) offshore funds that are majority-owned by U.S. persons or that have their principal place of business in the United States would be treated as U.S. person (and presumably substituted compliance would not be available).

While the Path Forward provides some milestone dates, they are not phrased as ”deadlines.”

Lofchie Comment:  The Path Forward appears to reflect recognition by the CFTC that EC regulated swap dealers are subject to comparable regulation, and thus that the CFTC will generally defer to EC regulators. Accordingly, the agreement by the CFTC with EC seems, at least as a general matter, to be a concession by the CFTC that it can not go its own way in international financial regulation; further, the CFTC’s agreement seems to bring the CFTC back into line with the SEC in terms of working out an approach for cross-border co-operation.

It is a tremendous positive that the CFTC has moved off its go-it-alone approach to work with European regulators, and hopefully with the SEC and with other non-U.S. regulators.  That said, the “Path Forward” is a brief statement, not a detailed rulemaking.  All of the details are left open.  It seems now appropriate for the CFTC to follow the lead of the SEC and to publish a proposed rule that would be subject to comment by market participants in the United States.  The implications of the proposal for cross-border competition are quite significant.  A rule that is not well considered could further disadvantage U.S-based institutions or could motivate U.S. clients to move their business away from the United States.  Please note that the Path Forward only deals with Europe; it does not make mention of Canada or various Asian jurisdictions. 

See:  CFTC Press Release.

CFTC Commissioner Jill Sommers released a statement supporting Commissioner Wetjen’s proposal of an interim final guidance that would be based on industry and public feedback, after Chairman Gensler had criticized the idea of delaying cross-border rules at a Senate Appropriations hearing. (For those interested in viewing Chairman Gensler’s remarks, certain of the most significant aspects of Chairman Gensler’s responses to questioning from the Senators is from approximately 1:35 to 1:45 into the hearing, and comes particularly in response to Senator Johanns.)  Immediately following Chairman Gensler’s responses to questions, SEC Chairman White stated that the SEC would move in a more deliberate fashion than the CFTC and would consider comments on its proposed rulemaking.

Commissioner Sommers expressed her support for Commissioner Wetjen, and her general disagreement with Chairman Gensler  by stating, “No one has ever accused Gary Gensler of being reasonable, but Commissioner Wetjen has put a reasonable proposal [for delay of the cross-border rules] on the table that would achieve multiple goals.” 

The same story reported that six Democratic Senators had urged CFTC Chairman Gensler to delay the application of the CFTC’s cross-border rules. 

Lofchie Comment:  The criticism of Chairman Gensler comes in reaction to a number of statements made by Chairman Gensler, most particularly (i) his published statement on the imposition on cross-border regulation (linked below) and (ii) his responses to questions before the a subcommittee of the Senate Appropriations Committee (also linked below).

There were a number of aspects of Chairman Gensler’s responses to questions from the Senators on cross-border regulation that emphasized how significant the uncertainty is in this area. Three examples of this are below:

One, Chairman Gensler stated that the CFTC was open to a program of substituted compliance by non-U.S. financial institutions, yet at the same time indicated that no other jurisdiction had in place a comprehensive scheme of regulation that would justify substituted compliance. Taking these two aspects of his remarks together, one was left with the impression that the Chairman would not accept substituted compliance when the CFTC’s current exemptive order expires on July 12, although he did not say so directly. Does that mean that Chairman Gensler believes that all non-U.S. firms registered as swap dealers should be subject to the full range of U.S. regulation, at least for the intermediate future?

Two, as to Canada, he indicated that only two of the provinces had schemes of regulation for derivatives and the other provinces did not. Given that the major Canadian banks operate in more than one province, does that mean that the CFTC intends to regulate the major Canadian banks extensively for the long term?  

Three, Chairman Gensler indicated that non-U.S. funds with U.S. advisers should be treated as U.S. persons under Dodd-Frank. He did not indicate whether that would include funds with non-U.S. ownership or how funds with a mix of U.S. and non-U.S. ownership should be treated. Nor did he indicate whether he would accept European jurisdiction over funds with European advisers, if such funds had some degree of U.S. ownership. In other words, how does the CFTC intend to resolve with Europe the issue of regulatory citizenship where an entity has some links to both the United States and Europe?

The existence of the tremendous uncertainties inherent in the three above questions argues strongly for the CFTC not to impose a blackbox of cross-border rules on global markets on July 12, but rather to follow the SEC’s course in proposing a full cross-border rule, which would be published in the Federal Register, and available for comment.

As to the need for fast action by the CFTC,  one may see some tension in (i) on the one hand, the CFTC Chairman arguing the urgency of the cross-border regulation of swaps by the CFTC and (ii) on the other hand, on the same day, the CFTC bringing a civil action for the loss of $1 billion of customer money by one of the largest CFTC-regulated firms.

See: Bloomberg Coverage of Sommers Statement and Senators’ Letter.
See also:  Chairman Gensler’s Responses to Questions before the Senate; Chairman Gensler on International Swaps Market Reform.

Commissioner Wetjen delivered a speech at the FIA and FOA International Derivatives Expo discussing the global scope of the CFTC and the implementation of Dodd-Frank overseas.  The Commissioner’s speech focused on the final implementation of Dodd-Frank in the coming weeks, especially the legislation’s cross-border policy.  In his remarks, he outlined the main objectives which he believes the CFTC must reach through cross-border guidance and relief:

• The CFTC’s Cross-Border Policy Must Protect the U.S. Taxpayer and Financial System: The Commissioner stated that the financial crisis taught global citizens that financial activities which appear to be local can have global consequences. The CFTC’s cross-border policy will account for the varied ways that risk can be imported into the U.S. and the promotion of international harmonization.
• The CFTC Must Protect the U.S. Financial System but Avoid Fragmenting Liquidity and Creating Unfair Competitive Advantages for Some Firms and Markets: The Commissioner confirmed that the CFTC’s cross-border guidance and Dodd-Frank provisions will comply in appropriate cases with “comparable and comprehensive” foreign regimes. Furthermore, the Commissioner clarified the CFTC’s approach as it relates to transaction-level requirements including clearing, reporting, and execution.
• The CFTC Must Adopt a Cross-Border Policy That Is Clear and Workable, Which Requires an Orderly Transition Period: The Commissioner stated that the CFTC and other financial regulators must be willing to revisit any cross-border framework and remain open to a “course of correction,” as developments in global and domestic derivative markets dictate.
• The Commissioner closed by stating he believed that the CFTC should adopt “interim final guidance in the coming weeks and seek additional comment on an interim approach that provides the legal certainty needed for the markets in the short term. . . .”

Lofchie Comment:  The Commissioner delivered what seemed to be a thoughtful and reasoned speech as to the difficulties in adopting a workable scheme of cross-border regulation.  However, he then closed his remarks with recommendations that seemed inconsistent with the tenor of most of his speech.  It is now June 25th; the current guidance on cross-border issues expires on July 12th.  No one in the market (buy-side or sell-side), nor any non-U.S. regulator, has any clear notion of what a final CFTC rule on the cross-border application of Title VII will look like.  Yet the Commissioner believes that the CFTC can adopt a workable cross-border “rule” (which cannot be called a rule because it has not been through any of the legal formalities of rulemaking) before July 12th, and do so without the benefit of either public comment, or coordination with the SEC or non-U.S. regulators.

Such a course of action would be imprudent.  When the CFTC’s choices are either (i) rush to beat an artificially imposed three-week deadline that can be readily extended or (ii) extend the current guidance and use the delay to publish a carefully considered rule proposal that could be modified in light of comments from U.S. market participants and non-U.S. regulators, as well as coordination with the SEC, the second choice seems obvious.   That so much time has passed since the adoption of Dodd-Frank does not justify haste now.  That the CFTC has not yet published a carefully considered rule proposal on cross-border issues reflects the choices that the CFTC has made to date, not a result that was forced upon the CFTC.

See:  Commissioner Wetjen’s Full Remarks Here.
See also:  SIFMA Statement on Commissioner Wetjen’s Remarks on Cross-Border Treatment of Derivatives.

The Office of the Comptroller of the Currency (OCC) has issued a rule finalizing  amendments to 12 CFR Part 32, which governs lending limits.  The rule implements Dodd-Frank Section 610, which applies the lending limit statute to credit exposures arising from derivative transactions and securities financing transactions, and makes other changes.

Effective Dates:  Under the rule, a temporary exception period is extended for three months so that compliance with the Section 610 provisions will not be required until October 1, 2013.  The effective date of amendatory instruction 2b of this final rule is July 2.

See:  Final Rule Release.