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 compliance.”
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 clients.”