The Securities and Exchange Commission (SEC) has stepped out of the shadows to enforce US regulatory requirements on foreign banking operations, though issues remain in its cross-border reach.
Under the SEC’s new rules, the sweeping new derivatives regulations will apply to foreign affiliates whose swap trades are guaranteed by US banks.
The rules will not affect subsidiaries in other jurisdictions, which are not guaranteed by a US bank, creating what some in the industry are calling a loophole in the regulation.
This means foreign divisions of some of the biggest banks in the US will not be forced to comply with US rules.
While not an illegal practice, the issue means regulators will struggle to achieve their goal of a fully regulated and transparent OTC derivatives market.
SEC chair, Mary Jo White, made it abundantly clear in her speech regarding the rules that the Commission had limitations within which it must operate.
“You now have an onshore market and an offshore market, and a US liquidity pool and a non-US persons liquidity pool,” said David Clark, chairman of the Wholesale Markets Brokers Association (WMBA).
“In reality what has happened is that the American banks have, or are, phasing out their guaranteed affiliates, which are clearly US persons, in favour of wholly-owned subsidiaries.
“This is not the exploitation of loopholes or regulatory arbitrage it is just an unintended consequence, what we have got is a result of the rollout of US rules.”
The cross-border application of the US derivatives rules has been intensely debated as the SEC and Commodity Futures Trading Commission (CFTC) look to enforce the regulations on banks in other jurisdictions.
It has been almost a year since the CFTC outlined its stance on cross-border applications, while the SEC has dragged its heels in defining who will fall under its rules.
With Europe already enforcing its own reforms, and the cost of trading under new regulations increasing, firms outside of the US will be keen to avoid the reach of the regulators in the US.
These overseas entities that do not have the parent guarantee will escape the reach of the US Dodd-Frank rules.
“Those subsidiaries are not US persons as they are actually completely different legal entities which are separately capitalised, with separate liquidity ratios and, if operating in London, regulated by the Bank of England's Prudential Regulatory Authority,” added Clark.
“So any business they do is not going to be caught within the framework either of the CFTC or the SEC.”
The SEC’s more narrow approach is in stark contrast to the CFTC’s rules, which landed it a court battle due to the extensive reach of its regulations.
Those facing the CFTC in court are the International Swaps and Derivatives Association along with the Securities Industry and Financial Markets Association (SIFMA).
The SEC received support from SIFMA with its toned-down international reach.
"We appreciate the SEC moving forward through the appropriate rulemaking process to adopt cross-border rules,” said Kenneth Bentsen Jr, president and CEO, SIFMA.
“Given the global nature of the swaps market, it is essential that we have clarity on jurisdictional lines and that we continue to work with regulators in other jurisdictions to promote coordination in the oversight of our markets.”