Dodd-Frank Derivatives Reform: Challenges Facing U.S. and International Markets
AT TODAY’S HOUSE AGRICULTURE SUBCOMMITTEE HEARING, lawmakers heard from Commodity Futures Trading Commission (CFTC) Commissioners Jill Sommers and Bart Chilton, Masamichi Kono of the Financial Services Agency of Japan, and Patrick Pearson of the European Commission on the challenges facing U.S. and international markets over the implementation of derivatives reform under the Dodd-Frank Act.
Noting how this hearing marks the first time international regulators have testified before Congress on the Dodd-Frank Act, Subcommittee Chairman Michael Conaway (R-Texas) discussed the extent of concerns by foreign governments and international regulators over the CFTC’s proposed cross border interpretative guidance, which outlines how Dodd-Frank rules will apply outside of U.S. borders. He said foreign regulators have met many times with CFTC Chairman Gary Gensler on these issues, but that, based on Gensler’s testimony from yesterday’s House Financial Services Committee (HFSC) hearing on Title VII implementation, he does not “appear to be willing to compromise on his approach.” Stressing the fact that conflicting and inconsistent regulations could cause the global derivatives market to become more regionalized, Conaway called for a harmonized global approach to derivatives reform regulation.
Rep. David Scott (D-Ga.) noted concerns he has been hearing about the CFTC’s timing and coordination of Title VII rulemakings. He urged the CFTC to do a better job in sequencing rules and coordinating with international regulators, warning that the consequences of doing so would harm domestic businesses.
Testimony
In his opening statement, Chilton discussed the progress of the CFTC in finalizing Dodd-Frank rules and said that various delays and extensions of some rule requirements have enabled the rest of the international community to “catch up” with similar reform initiatives. He discussed the issues surrounding the October 12 compliance date, noting how the CFTC should have communicated to market participants in a more transparent and streamlined fashion. Chilton said that such an approach needs to be avoided for the year-end compliance timeframes and recommended: extending the narrower definition of “U.S. person” in the October staff no-action letter; providing interim relief for swap dealers and major swap participants from external business conduct standards; allowing non-U.S. dealers to not register when facing registered U.S. persons; and providing relief related to the swaps dealing aggregation standard. He also called on the Commission to immediately respond to those who have requested relief.
In her opening statement, Sommers provided an overview of the CFTC’s Global Markets Advisory Committee meeting in November and discussed the outcome of the November 28 meeting with international derivatives regulators. She acknowledged that the pace of global reform efforts has been uneven, but the ability to reach comparable or equivalent regulation is achievable. She added that assessments of regulatory comparability should be made at a high level, and noted the importance of ensuring a level playing field for U.S. firms, who will be subject to new regulations while the rest of the world is still working to finalize their reforms.
In his opening statement, Kono discussed derivatives reform efforts in Japan and urged international regulators to avoid conflicting or overlapping cross border regulations. He stressed the importance of providing transparency before significant regulations are implemented and stated that a sufficient transition period should be provided for firms to come into compliance. Kono also noted that when adopting an approach of reliance on foreign regulators, it “should be based on a clear recognition of the foreign regulators’ primary authority and competence in exercising effective regulation of entities and infrastructures based in its jurisdiction.”
In his opening statement, Pearson discussed the need for further work on cross border regulation between the U.S. and the European Union (EU). He noted how “recent detailed analysis of U.S and EU rules has identified numerous potential conflicts, inconsistencies and gaps…that should be addressed through mutually acceptable solutions.” Pearson also raised concerns over proposals from the CFTC that would extend the agency’s reach to counterparties outside of the U.S. He said it is important for counterparties in two jurisdictions to be subject to the G20 requirements, and that achieving such goals is better done by “ensuring comparability of rules than by over-extending the reach of national rules.”
He also called for registration requirements to apply only to jurisdictions that lack comparable and consistent requirements. “To the extent that registration is unavoidable, it should be combined, from the very outset, with recognition/substituted compliance in order to limit, as far as possible, any legal complications and burdens,” Pearson said.
Question and Answer
Conaway expressed his concern that the CFTC and the Securities and Exchange Commission (SEC) have not issued a common definition of “U.S. person.” He asked if there was a law that prevents the CFTC from issuing a joint rule or guidance that harmonizes the definitions. Sommers stated that she is unaware of any provision that would prevent the CFTC from doing so but stressed that the CFTC has been coordinating with the SEC all along. She said staffs of both agencies are working to find common ground, but that “we are not there yet.”
Conaway followed up asking what additional rules the CFTC would release by the end of the year. Sommers said the Commission is working through a final exemptive order that would grant entities relief from registration requirements for a certain time period. Scott asked a similar question and Sommers stated her hope that “clear” relief will be provided to market participants within the next week.
Scott followed up by highlighting a speech made by Chilton earlier this year in which he suggested the CFTC could finalize cross border guidance by June 2013.
Chilton clarified that he hopes the CFTC can vote on the measure “ASAP” and then have compliance delayed until “June 1 or perhaps July, whatever makes sense.”
Full Committee Chairman Frank Lucas (R-Okla.) referred to comments made by Chairman Gensler during yesterday’s hearing regarding cost-benefit analysis, and asked if any analysis has been done on the cross border guidance and exemptive order. Sommers said economic analysis is included in the exemptive order that is currently circulating within the Commission.
Scott noted comments made by Kono during the CFTC’s Global Markets Advisory Committee meeting last month regarding businesses that decline transactions with U.S. counterparties due to the uncertainty associated with U.S. regulations. He asked if U.S. regulators have been able to provide more clarity for market participants. Kono said Japanese financial services providers will be able to conduct normal business with U.S. counterparts but said more work needs to be done as it relates to uncertainty over requirements stemming from registration with the CFTC. He stated that Japanese firms are willing to do business with the U.S. as long as they are given more transparency in associated rules.
Scott referred to Pearson’s testimony, noting how he has “laid the gauntlet down to challenge our regulators” in developing coordinated and harmonized regulatory regimes, and asked for Chilton’s and Sommer’s reaction to his statements. Sommers said compliance requirements are the root of the problem.
In later questioning, she noted how the SEC’s approach of passing the rules first and then requiring compliance is more sensible because requiring compliance before all the rules are finished is problematic for market participants.
Conaway referred to comments made by Gensler during yesterday’s hearing regarding how he would allow substituted compliance and would defer to the rules of foreign jurisdictions if those rules are “real.” Conaway then questioned the standards the CFTC will be using to determine comparability. Pearson responded by stating that the issues center on the willingness of regulators to defer to the rules of other jurisdictions. He stated his belief that the CFTC needs to defer more on transaction requirements to avoid overlapping and inconsistent rules. Pearson went on to explain that the major unresolved issues related to global coordination of reform roles deal with scope. He said the EU is prepared to limit the scope of the extraterritorial application of its rules if other foreign regulators are willing to do the same.
Rep. Joe Courtney (D-Conn.) asked the CFTC Commissioners to comment on the recent court decision regarding the CFTC’s position limits rule. Chilton said the CFTC appealed the District Court’s decision to strike down the rule and that staff is currently working on a new rule that he hopes will be approved “some time in the first quarter” of 2013. He noted how this rule would benefit from additional data that was made available following the October 12 compliance requirements.
Rep. Steve King (R-Iowa) referred to Sommer’s testimony in which she said the CFTC’s interpretation of “direct and significant” with regard to determining whether cross border entities and activities have a nexus to the U.S. that would entail the application of Dodd-Frank rules was too broad. Sommers explained her belief that the CFTC’s cross border interpretative guidance suggested that if a swap had a “direct” connection to the U.S. then it should fall under Dodd-Frank jurisdiction, but the guidance did not sufficiently explain the “significant” connection.
Rep. Terri Sewell (D-Ala.) pointed to legislation she cosponsored which repeals the Dodd-Frank indemnification requirements (H.R. 4235), stating her hope that the bill would receive full House consideration in the near future. She asked whether the CFTC will ever strike the indemnification provision and would support H.R. 4235. Both Commissioners Sommers and Chilton expressed their support for the legislation.
Rep. John Garamendi (D-Calif.) noted comments from Chilton’s testimony regarding work on high frequency trading and asked for an update on what the Commission is doing in this area. Chilton noted a recent report put out by the Commission that shows how high frequency traders provide lots of “fleeting” liquidity which helps exacerbate volatility. He said the Commission needs to do a better job of policing high frequency trading, noting how such entities are not required to register. Due to work on Dodd-Frank implementation, Chilton said the CFTC has not been able to focus very closely on the issue.
Rep. Christopher Gibson (R-N.Y.) asked for Kono’s and Pearson’s recommendations on how to achieve closer global coordination of reform efforts. Kono said regulators have agreed to hold regular meetings on reform issues and to develop agreements that better enable the exchange of information. Pearson said regulators need to first agree that there are problems in the rules that need fixing and that sufficient timing needs to be giving to implement those rules. He also added that issues with registration requirements need to be addressed, noting how “it does not make sense” to require firms to register if they do not know what that registration entails.
Rep. Renee Ellmers (R-N.C.) pointed to comments made by Gensler during yesterday’s HFSC hearing where he stated that not covering guaranteed affiliates offshore will “blow a hole out of Dodd-Frank.” She stated her belief that the comments reflect a lack of faith in the ability of foreign governments to regulate such entities. Pearson responded by noting that the risk Gensler is referring to works both ways, explaining how U.S. affiliates can drive risk to Europe. He said comparability of rules must be based on trust and an understanding of regulatory regimes on both sides of the Atlantic. He said if the EU were to try to enforce its rules on all of its affiliates in the U.S., “we would be doing two things that are horribly wrong…we would be trying to enforce something that we cannot.” “Even worse, we would be giving the impression that we will be able to enforce this,” Pearson said.
For testimony and a webcast of the hearing, please click here.
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AT TODAY’S HOUSE AGRICULTURE SUBCOMMITTEE HEARING, lawmakers heard from Commodity Futures Trading Commission (CFTC) Commissioners Jill Sommers and Bart Chilton, Masamichi Kono of the Financial Services Agency of Japan, and Patrick Pearson of the European Commission on the challenges facing U.S. and international markets over the implementation of derivatives reform under the Dodd-Frank Act.
Noting how this hearing marks the first time international regulators have testified before Congress on the Dodd-Frank Act, Subcommittee Chairman Michael Conaway (R-Texas) discussed the extent of concerns by foreign governments and international regulators over the CFTC’s proposed cross border interpretative guidance, which outlines how Dodd-Frank rules will apply outside of U.S. borders. He said foreign regulators have met many times with CFTC Chairman Gary Gensler on these issues, but that, based on Gensler’s testimony from yesterday’s House Financial Services Committee (HFSC) hearing on Title VII implementation, he does not “appear to be willing to compromise on his approach.” Stressing the fact that conflicting and inconsistent regulations could cause the global derivatives market to become more regionalized, Conaway called for a harmonized global approach to derivatives reform regulation.
Rep. David Scott (D-Ga.) noted concerns he has been hearing about the CFTC’s timing and coordination of Title VII rulemakings. He urged the CFTC to do a better job in sequencing rules and coordinating with international regulators, warning that the consequences of doing so would harm domestic businesses.
Testimony
In his opening statement, Chilton discussed the progress of the CFTC in finalizing Dodd-Frank rules and said that various delays and extensions of some rule requirements have enabled the rest of the international community to “catch up” with similar reform initiatives. He discussed the issues surrounding the October 12 compliance date, noting how the CFTC should have communicated to market participants in a more transparent and streamlined fashion. Chilton said that such an approach needs to be avoided for the year-end compliance timeframes and recommended: extending the narrower definition of “U.S. person” in the October staff no-action letter; providing interim relief for swap dealers and major swap participants from external business conduct standards; allowing non-U.S. dealers to not register when facing registered U.S. persons; and providing relief related to the swaps dealing aggregation standard. He also called on the Commission to immediately respond to those who have requested relief.
In her opening statement, Sommers provided an overview of the CFTC’s Global Markets Advisory Committee meeting in November and discussed the outcome of the November 28 meeting with international derivatives regulators. She acknowledged that the pace of global reform efforts has been uneven, but the ability to reach comparable or equivalent regulation is achievable. She added that assessments of regulatory comparability should be made at a high level, and noted the importance of ensuring a level playing field for U.S. firms, who will be subject to new regulations while the rest of the world is still working to finalize their reforms.
In his opening statement, Kono discussed derivatives reform efforts in Japan and urged international regulators to avoid conflicting or overlapping cross border regulations. He stressed the importance of providing transparency before significant regulations are implemented and stated that a sufficient transition period should be provided for firms to come into compliance. Kono also noted that when adopting an approach of reliance on foreign regulators, it “should be based on a clear recognition of the foreign regulators’ primary authority and competence in exercising effective regulation of entities and infrastructures based in its jurisdiction.”
In his opening statement, Pearson discussed the need for further work on cross border regulation between the U.S. and the European Union (EU). He noted how “recent detailed analysis of U.S and EU rules has identified numerous potential conflicts, inconsistencies and gaps…that should be addressed through mutually acceptable solutions.” Pearson also raised concerns over proposals from the CFTC that would extend the agency’s reach to counterparties outside of the U.S. He said it is important for counterparties in two jurisdictions to be subject to the G20 requirements, and that achieving such goals is better done by “ensuring comparability of rules than by over-extending the reach of national rules.”
He also called for registration requirements to apply only to jurisdictions that lack comparable and consistent requirements. “To the extent that registration is unavoidable, it should be combined, from the very outset, with recognition/substituted compliance in order to limit, as far as possible, any legal complications and burdens,” Pearson said.
Question and Answer
Conaway expressed his concern that the CFTC and the Securities and Exchange Commission (SEC) have not issued a common definition of “U.S. person.” He asked if there was a law that prevents the CFTC from issuing a joint rule or guidance that harmonizes the definitions. Sommers stated that she is unaware of any provision that would prevent the CFTC from doing so but stressed that the CFTC has been coordinating with the SEC all along. She said staffs of both agencies are working to find common ground, but that “we are not there yet.”
Conaway followed up asking what additional rules the CFTC would release by the end of the year. Sommers said the Commission is working through a final exemptive order that would grant entities relief from registration requirements for a certain time period. Scott asked a similar question and Sommers stated her hope that “clear” relief will be provided to market participants within the next week.
Scott followed up by highlighting a speech made by Chilton earlier this year in which he suggested the CFTC could finalize cross border guidance by June 2013.
Chilton clarified that he hopes the CFTC can vote on the measure “ASAP” and then have compliance delayed until “June 1 or perhaps July, whatever makes sense.”
Full Committee Chairman Frank Lucas (R-Okla.) referred to comments made by Chairman Gensler during yesterday’s hearing regarding cost-benefit analysis, and asked if any analysis has been done on the cross border guidance and exemptive order. Sommers said economic analysis is included in the exemptive order that is currently circulating within the Commission.
Scott noted comments made by Kono during the CFTC’s Global Markets Advisory Committee meeting last month regarding businesses that decline transactions with U.S. counterparties due to the uncertainty associated with U.S. regulations. He asked if U.S. regulators have been able to provide more clarity for market participants. Kono said Japanese financial services providers will be able to conduct normal business with U.S. counterparts but said more work needs to be done as it relates to uncertainty over requirements stemming from registration with the CFTC. He stated that Japanese firms are willing to do business with the U.S. as long as they are given more transparency in associated rules.
Scott referred to Pearson’s testimony, noting how he has “laid the gauntlet down to challenge our regulators” in developing coordinated and harmonized regulatory regimes, and asked for Chilton’s and Sommer’s reaction to his statements. Sommers said compliance requirements are the root of the problem.
In later questioning, she noted how the SEC’s approach of passing the rules first and then requiring compliance is more sensible because requiring compliance before all the rules are finished is problematic for market participants.
Conaway referred to comments made by Gensler during yesterday’s hearing regarding how he would allow substituted compliance and would defer to the rules of foreign jurisdictions if those rules are “real.” Conaway then questioned the standards the CFTC will be using to determine comparability. Pearson responded by stating that the issues center on the willingness of regulators to defer to the rules of other jurisdictions. He stated his belief that the CFTC needs to defer more on transaction requirements to avoid overlapping and inconsistent rules. Pearson went on to explain that the major unresolved issues related to global coordination of reform roles deal with scope. He said the EU is prepared to limit the scope of the extraterritorial application of its rules if other foreign regulators are willing to do the same.
Rep. Joe Courtney (D-Conn.) asked the CFTC Commissioners to comment on the recent court decision regarding the CFTC’s position limits rule. Chilton said the CFTC appealed the District Court’s decision to strike down the rule and that staff is currently working on a new rule that he hopes will be approved “some time in the first quarter” of 2013. He noted how this rule would benefit from additional data that was made available following the October 12 compliance requirements.
Rep. Steve King (R-Iowa) referred to Sommer’s testimony in which she said the CFTC’s interpretation of “direct and significant” with regard to determining whether cross border entities and activities have a nexus to the U.S. that would entail the application of Dodd-Frank rules was too broad. Sommers explained her belief that the CFTC’s cross border interpretative guidance suggested that if a swap had a “direct” connection to the U.S. then it should fall under Dodd-Frank jurisdiction, but the guidance did not sufficiently explain the “significant” connection.
Rep. Terri Sewell (D-Ala.) pointed to legislation she cosponsored which repeals the Dodd-Frank indemnification requirements (H.R. 4235), stating her hope that the bill would receive full House consideration in the near future. She asked whether the CFTC will ever strike the indemnification provision and would support H.R. 4235. Both Commissioners Sommers and Chilton expressed their support for the legislation.
Rep. John Garamendi (D-Calif.) noted comments from Chilton’s testimony regarding work on high frequency trading and asked for an update on what the Commission is doing in this area. Chilton noted a recent report put out by the Commission that shows how high frequency traders provide lots of “fleeting” liquidity which helps exacerbate volatility. He said the Commission needs to do a better job of policing high frequency trading, noting how such entities are not required to register. Due to work on Dodd-Frank implementation, Chilton said the CFTC has not been able to focus very closely on the issue.
Rep. Christopher Gibson (R-N.Y.) asked for Kono’s and Pearson’s recommendations on how to achieve closer global coordination of reform efforts. Kono said regulators have agreed to hold regular meetings on reform issues and to develop agreements that better enable the exchange of information. Pearson said regulators need to first agree that there are problems in the rules that need fixing and that sufficient timing needs to be giving to implement those rules. He also added that issues with registration requirements need to be addressed, noting how “it does not make sense” to require firms to register if they do not know what that registration entails.
Rep. Renee Ellmers (R-N.C.) pointed to comments made by Gensler during yesterday’s HFSC hearing where he stated that not covering guaranteed affiliates offshore will “blow a hole out of Dodd-Frank.” She stated her belief that the comments reflect a lack of faith in the ability of foreign governments to regulate such entities. Pearson responded by noting that the risk Gensler is referring to works both ways, explaining how U.S. affiliates can drive risk to Europe. He said comparability of rules must be based on trust and an understanding of regulatory regimes on both sides of the Atlantic. He said if the EU were to try to enforce its rules on all of its affiliates in the U.S., “we would be doing two things that are horribly wrong…we would be trying to enforce something that we cannot.” “Even worse, we would be giving the impression that we will be able to enforce this,” Pearson said.
For testimony and a webcast of the hearing, please click here.