CFTC Approves Substituted Compliance for Japan's Uncleared Swap Margin Requirements
Commentary by Bob Zwirb
The CFTC approved, by a two-to-one vote, a comparability determination that will allow substituted compliance with Japan's margin requirements for uncleared swaps.
In a statement at the open meeting, CFTC Chair Timothy Massad voiced his support for the margin comparability determination for Japan, notwithstanding certain differences between that country's practices and those of the United States. He noted that "our laws and the laws of other jurisdictions will never be identical."
Though voting to permit substituted compliance for Japan, Commissioner J Christopher Giancarlo noted that the rule could be problematic:
[T]his rule's subjectivity and complexity will continue to be a source of regulatory uncertainty at the expense of U.S. financial firms, their employees and the American businesses they serve. In this instance, the [CFTC] has appropriately recognized that certain differences between the U.S. margin regime and Japan's margin regime achieve comparable outcomes. Wrong approach; right outcome. I therefore vote in favor of the determination.
CFTC Commissioner Sharon Y. Bowen dissented on the margin comparability determination. She argued that it will "introduce greater risk into the derivatives markets," particularly in the case of certain bankruptcy scenarios. Commissioner Bowen recommended that the CFTC "provide a partial comparability determination. . . . American businesses could follow the Japanese margin rule except in [certain areas]... where they would have to follow the [American] rule."
Commentary
Commissioner Bowen's critique of the CFTC's comparability determination raises important issues about the scope of the determination and the protection of customer collateral. In Commissioner Bowen's view, a foreign regulatory regime that is only "partly comparable" with ours concerning the handling of customer funds is insufficient. Customers affected by the determination, however, are not unsophisticated individuals, but rather eligible contract participants. Further, trading vehicles are not futures, but rather swaps. These distinctions seem to attenuate the case for greater harmonization.
On the futures side, where (theoretically) a better case could be made for requiring more conformity, the CFTC has relied historically on disclosure as the way to inform customers who trade on foreign exchanges that they "may not be afforded certain of the protections which apply to domestic transactions," and that "funds received from customers to margin foreign futures transactions may not be provided the same protections as funds received to margin futures transactions on domestic exchanges." Similarly, the CFTC's business conduct standards for swaps require swap dealers to disclose the "material risks" of each swap, including "legal" and "other applicable" risks.
Such disclosure might never satisfy the most consumer-protection-minded people. By and large, though, it has worked well over a period of decades for U.S. customers who trade foreign futures and options. As Chair Massad was careful to remind us, the goal should be "comparability in outcomes," not "line-by-line identity."
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