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CFTC Chair Massad Discusses CFTC Rulemaking in an International Context (with Lofchie Comment)

CFTC Chair Timothy Massad discussed rulemaking priorities and how upcoming rulemakings, including clearinghouse regulation and margin for uncleared swaps, will affect cross-border market participants. He delivered his remarks at the Futures Industry Association's International Derivatives Conference. His speech focused on the CFTC's rulemaking priorities and how upcoming rulemakings, including clearinghouse regulation and margin for uncleared swaps, will affect cross-border market participants.

Chair Massad asserted that the CFTC and international regulators are making "good progress" on clearinghouse equivalence discussions. He noted that discussions with Lord Jonathan Hill led to agreement on terms of substituted compliance in the application of U.S. law to European clearinghouses that must be registered. Chair Massad emphasized that issues must be approached in a data-driven way in order for agreement. This includes analysis to evaluate the differences in regulatory systems. In particular, Chair Massad saw margin methodology issues as one area that regulators should approach using "pragmatic, data-driven analysis" in order to reach agreement.

Chair Massad went on to discuss certain cross-border aspects of the CFTC rules. He noted that in September 2014, the CFTC requested comments on a proposed rule on margin in cross-border transactions. The rule outlined three approaches:

  • the guidance approach, which would apply the margin rule in accordance with the CFTC's cross-border guidance on a transaction basis, with a broad exclusion for foreign-to-foreign trades;
  • the entity approach, which would apply the margin rule to all uncleared swaps of a registered swap dealer without any exclusions; and
  • the bank regulator's entity approach, which is similar to the entity-based approach, but provides for substituted compliance in many cases, as well as a limited exclusion where neither party is guaranteed or controlled by a U.S. person.

Chair Massad introduced another approach, which he called a "hybrid of the entity and transaction-level approaches." In the hybrid approach, U.S. swap dealers would be required to comply with the rule in all their transactions; however, in their transactions with certain non-U.S. counterparties, they would be entitled to substituted compliance with respect to margin they posted, but not the margin they collected. Additionally, non-U.S. swap dealers whose swap obligations are guaranteed by a U.S. person would be treated the same way. Chair Massad noted that substituted compliance would be available in the case of the laws of jurisdictions that the CFTC deemed comparable.

In the hybrid approach, non-U.S. swap dealers who were registered with the CFTC and whose obligations were not guaranteed by a U.S. person would be entitled to substituted compliance to a greater extent. Chair Massad pointed out that transactions by a non-U.S. swap dealer would be excluded from the rule only if both the swap dealer and its counterparty were neither guaranteed by a U.S. person nor consolidated in the financial statements of a U.S. person.

Chair Massad suggested that the CFTC fine-tune the hybrid approach in order to propose and request comment on it.

Lofchie Comment: This entire process provides a good example of the fundamental problem with having swaps margin determined by global regulators rather than by either (i) local national regulators who are responsible for the creditworthiness of the entities that they regulate or (ii) actual financial institutions that are subject to the capital regulations of their local national regulator. Given how long it is taking for the various regulators to agree (which is not to assume that any agreement they reach will be sound), imagine how impractical it would be for the global regulators ever to amend the terms of their agreement as circumstances changed. A world in which economic decisions are made by a single global regulatory system is the moral equivalent of "too big to fail." That is, if the conclusions reached are wrong, then it doesn't matter whether they are too liberal or too conservative. They cannot "fail" because there is nowhere else to go.

See: Chair Massad's Speech.

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