Institutions in Asia and beyond may choose to
restrict their swap trading activities and segregate their business with US
counterparties to keep regulatory costs under control and avoid falling foul of
extraterritorial American derivatives regulations, a new study from consultancy
Celent has asserted.
The report was released the day
the US Commodity Futures Trading Commission (CFTC) met with foreign regulators who
warned the agency that its attempts to extend new derivatives rules overseas
could severely harm global markets.
Under the CFTC’s rules – enshrined
in the Dodd-Frank Act to comply with G-20 recommendations to reduce systemic
risk in OTC derivatives trading – non-US banks trading with US counterparties must
register in the US as swap dealers and abide by CFTC rules on capital
requirements and risk management.
Regulators and foreign
governments have already made numerous requests to the CFTC to limit the extraterritoriality of Dodd-Frank. Giving witness Wednesday
at the public meeting in Washington DC were Masamichi Kono, vice commissioner
for international affairs at Japan’s Financial Services Agency, Fabrizio
Planta, senior officer of post-trading for the European Securities and Markets
Authority, and Patrick Pearson, head of Financial Markets Infrastructure in the
European Commission’s Internal Market Directorate General.
The extraterritorial nature of
Dodd-Frank was criticised for duplicating regulation which would lead to
substantial compliance costs and an environment of considerable uncertainty
which could reduce liquidity.
“The impact of Dodd-Frank for
foreign banks is going to be widespread and long-lasting. The new rules would
alter the trading strategies and operations of most of the large swap trading
firms globally,” wrote Anshuman Jaswal, senior analyst at Celent and author of
the Celent report titled ‘Extraterritoriality of the Dodd-Frank Act: Dealing
with new CFTC regulations’.
In order to cope with these
requirements, Jaswal said firms would have to undertake a thorough analysis of
the various business, tax, regulatory and capital factors.
“Hence, it is imperative these
banks clearly separate their trading activities with US counterparties from the
non-US counterparties for regulatory reporting purposes,” he advised.
Segregate or overlap?
In understanding the implications of the rules, Jaswal said a
number of factors need to be considered, including the institution’s location,
the nationality of counterparties, and applicable regulatory requirements.
Foreign firms will need to consider which of its entities trade swaps with US
persons and under which jurisdictions.
“The overlap in jurisdictions between the US and non-US
markets also needs to be taken into account. The implications for potential
transactions and future business also have to be considered because some firms
might choose to restrict their swap trading to keep regulatory costs under
control,” said Jaswal.
Firms also need to understand that the extraterritorial
reach of the new US laws differ at the entity and transaction level. While entity
level rules apply to all registered swap dealers, in certain circumstances,
overseas swap dealers can meet registration requirements by complying with
comparable foreign regulations. However, transaction level requirements apply
to all US-facing transactions, explained Jaswal. For these rules, US-facing
transactions include not just transactions with persons or entities operating
or incorporated in the US, but also transactions with their overseas branches.
“In effect, the new rules mean that if a legal entity has
over US$8 billion in US swap dealing activity, it should be preparing to
register as a swap dealer,” said Jaswal. “As a swap dealer, the entity would
have to comply with the various Dodd-Frank provisions applicable to swap
dealers, though in certain cases, this may be done through substituted
The registration of all market participants acting as swapdealers or a major swap participants was
required by 15 October, although certain exceptions apply.
“An important trade-off that foreign banks have to consider
is whether it would be easier to build their capabilities for dealing with both
US and non-US clients simultaneously, as opposed to doing so sequentially,”
said Jaswal. “The benefit of doing so at the same time is that the process
might be faster and would take advantage of the obvious overlap from an
operational and technological point of view of the trading with both types of