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CFTC Chair Proposes Alternative Cross-Border Framework

Commentary by Steven Lofchie and Nihal Patel

CFTC Chair J. Christopher Giancarlo proposed an alternative cross-border swaps framework to "better balance systemic risk mitigation with healthy swaps market activity in support of broad-based economic growth."

In a new white paper, he previewed weeks ago, Mr. Giancarlo outlined his views on the current CFTC approach to regulating cross-border activities and suggested a new approach that would encourage greater cooperation with non-U.S. jurisdictions. Mr. Giancarlo recommended, among other things:

  • Non-U.S. Central Clearing Parties ("CCPs"): expanding the use of the CFTC's exemptive authority for non-U.S. CCPs that are subject to similar regulations in their home country and do not pose risk to the U.S. financial system;
  • Non-U.S. trading venues: terminating the bifurcation of the global swaps market into separate U.S. person and non-U.S. person marketplaces by exempting non-U.S. trading venues, in regulatory jurisdictions that have adopted similar G20 swaps reform, from having to register with the CFTC as swap execution facilities;
  • Non-U.S. swap dealers: regulating non-U.S. swap dealers whose swap-dealing activity poses a material risk to the U.S. financial system;
  • Clearing and trade execution requirements: allowing non-U.S. persons to rely on substituted compliance as to swap clearing and trade execution requirements in comparable jurisdictions; and
  • Arrange, negotiate, or execute swap transactions: taking a "territorial approach to the U.S. swaps trading activity," as non-incidental swaps trading activity in the United States should be subject to U.S. swaps trading rules.

Commentary

Market participants should be aware that while Chair Giancarlo is, in many respects, advocating for less U.S. regulation, and more deferences to home country regulators, he is not advocating for a deregulatory approach. In fact, in a number of regards, he would expand the scope of U.S. swaps regulation, perhaps most significantly as to swaps that are "arranged, negotiated or executed" in the United States by non-U.S. swap dealers. It is not clear what additional steps he would take in regard to the regulation of non-U.S. swap dealers whose activity pose a material risk to the U.S. financial system (or by what criteria he would determine which swap dealers posed such a risk).  

Beyond the substance of what Chair Giancarlo is proposing, what is really fascinating is the manner in which he is pushing the direction of the CFTC, and how he prepared for that push even while being a Commissioner in the minority party; that is, through the publication of white papers, he has established himself as an intellectual and thought leader for the direction of regulation.  This has not only established his acumen – he has also freed himself from the constraints of the bureaucratic process.  There are probably not too many other regulators who would be able to exert influence in this manner, but one possibility is SEC Commissioner Peirce. 

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Commentary

Mr. Giancarlo's paper is essentially the long-form version of a speech he gave in London recently. There are a number of areas where the additional detail is notable.

  • Mr. Giancarlo is advocating for the CFTC to grant exemptions for non-U.S. CCPs to offer services to U.S. customers through non-U.S. clearing members, with only non-U.S. bankruptcy law applying to insolvency of the clearing member or CCO. He justifies this policy choice by noting the "professional nature" of the swaps market, and that the approach would allow institutional market participants to make the commercial decision whether to business with clearing firms subject to U.S. or non-U.S. insolvency law. This policy rationale - which is (i) accurate given that the CEA limits swaps to "eligible contract participants" and (ii) consistent with the CFTC approach to futures - is important for how it differs from other ways in which Title VII was adopted and implemented. In a handful of places, Congress and the CFTC have applied customer protection concepts borrowed from securities laws written with retail customers in mind (e.g., suitability requirements). In addition, Mr. Giancarlo's policy recommendation raises a question as to what impact the increased customer choice will have on U.S. market participants. For example, it is possible that the change could have an adverse competitive impact on U.S. FCMs that do not have affiliated non-U.S. clearing firms. In addition, it is possible that the optionality could be limited if clearing firms find it difficult to engage in transactions on non-U.S. CCPs through a U.S. regulated entity (i.e., firms essentially only offer the non-U.S. bankruptcy regime as a choice). See pp. 42-46.
  • Mr. Giancarlo would permit non-U.S. execution platforms to be exempt from CFTC registration and to permit trading by U.S. participants. While this might raise similar concerns as those of the clearing exemptions, it would be a benefit to the liquidity of trading platforms. See pp. 51-53.
  • Mr. Giancarlo advocates (mercifully) getting rid of the "affiliate conduit" concept from the CFTC Cross-Border Guidance. See fn. 57.
  • Mr. Giancarlo suggests only mild changes to the Cross-Border Guidance approach in determining which swaps count for purposes of the swap dealer de minimis threshold with respect to persons in "comparable jurisdictions." U.S. dealers and U.S.-guaranteed dealers would continue to be required to count all swaps, while foreign dealers continue to be required to count swaps with U.S. persons, U.S.-guaranteed persons, and foreign branches of U.S. swap dealers. In a footnote, Mr. Giancarlo suggests an alternative approach to carve this back somewhat: by not requiring foreign dealers to count transactions with U.S.-guaranteed persons, consistent with the approach taken by the SEC in their security-based swap rules. See p. 65 & fn. 141. Mr. Giancarlo also would apply a separate approach as to dealers acting in "non-comparable jurisdictions." Such dealers would need to count a slightly broader scope of transactions and Mr. Giancarlo is directing the CFTC staff to further consider how to handle issues relating to dealers in these jurisdictions. See pp. 68-69.

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