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July 11, 2013 6:28 pm
It was billed as the mother of regulatory crunches, the day the world’s regulators would part ways on policing derivatives. They would prevent clearing houses handling some US business and force dealers to apply conflicting rules.
In the event, on the eve of a deadline when the US would withdraw exemptions for foreign dealers, a landmark transatlantic accord has been sealed that calls a truce in a turf war that has threatened to disrupt financial markets.
For dealers such as Barclays, Deutsche Bank and JPMorgan Chase, it reduces uncertainty over who regulates them. Market activity will no longer have to shift to the US to comply with clearing and trading requirements.
Trading platforms in Europe will remain viable. European clearing houses will be able to tap US markets and serve US customers. EU officials’ nightmare over the US rules “sucking liquidity” out of Europe are unrealised.
The breakthrough starts putting together a jigsaw sketched out by global regulators, which united after the 2008 financial crisis to impose order on derivatives markets with common principles for clearing, trading and reporting. Through exemptions and accords, it sets a path for the EU and US to recognise rules so there is no need for either authority to enforce them outside their own jurisdiction.
“The big news is that they’ve knitted the two frameworks together and that’s a success,” says Will Rhode, director of fixed income research at Tabb, a US capital markets consultancy.
There was palpable relief in the industry. Yet while the most worrying threats of a confrontation have receded, the road to regulatory convergence remains long. John Wilson, global head of OTC clearing at Newedge, a futures broker, says the deal has “definitely reduced the level of concern that [the rules] will fragment liquidity, but it has not eliminated it”.
Anthony Belchambers, chief executive of the London-based Futures and Options Association, says it was “a very positive step forward – but this is not a quick win”.
Behind the numbingly complex detail of cross-border derivatives guidance, a bigger issue was at stake: whether Washington could trust Europeans to enforce financial rules designed to protect US taxpayers.
On one side, Gary Gensler of the Commodity Futures Trading Commission urged strict oversight of foreign trading to prevent blowback from reckless risk-taking abroad. To the EU this smacked of a land-grab that would create a “tower of Babel” of overlapping laws.
[The deal is] a very positive step forward – but this is not a quick win
- Anthony Belchambers, Futures and Options Association
Such was the concern, especially in the City of London, that finance ministers from nine countries joined forces to demand that Mr Gensler rethink. US politicians denounced the “London loophole” and EU officials claimed their executives would be forced to “choose between prisons”.
Complicating matters further was the technical and political difficulty of synchronising when and how common principles were translated into law, through legislation such as Dodd-Frank in the US and its EU equivalents: Emir, which has been passed, and Mifid, which is still being negotiated. Even the CFTC was riven. Inside the commission tensions built as Mr Gensler ran into resistance from a fellow Democrat. Mark Wetjen, the swing vote on the panel, last month attacked what he called an “arbitrary and self-imposed deadline” and pushed for revisions as a condition of support.
He got some of what he wanted. Mr Gensler had previously insisted that any transaction with a US counterparty fell under Dodd-Frank. Now the CFTC has determined that because EU and US rules are “essentially identical”, market participants can “determine their own choice of rules” when transacting privately negotiated swaps.
For business conduct rules, “compliance under Emir will achieve compliance with the relevant CFTC rules,” according to the agreement.
Swap transactions executed on what CFTC calls “foreign boards of trade” will also be allowed.
Mr Gensler, meanwhile, won a firm commitment to define US-based hedge funds incorporated offshore as American, ensuring their derivatives trading is subject to oversight.
The four-member CFTC was still scheduled to vote on its guidance and a compliance delay on Friday morning. Mr Wetjen said on Thursday he was “cautiously optimistic we will reach agreement on cross-border policy that will protect US taxpayers while at the same time incentivising an efficient market structure for swaps”.
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