Wall Street banks are warning they may have to cede much of the European derivatives market to the likes of Deutsche Bank and Barclays Capital if US regulators follow through on proposals to apply new regulations extraterritorially.
The Federal Reserve and other banking regulators recently proposed rules that would force the non-US arms of US banks to collect collateral, or “margin” in the form of cash or securities, “without regard to whether the counterparty is located inside or outside the United States”.
Four banks, who would not talk publicly, said it was the first inkling that US regulators wanted to enforce the Dodd-Frank Act beyond US shores.
“The margin rules were a bit of a shock,” said a US executive. “Most derivatives rules so far have been silent in terms of international issues. This rule was the first to address international treatment, and the rule would create an unlevel playing field outside the US. That is a huge concern.”
As in the US, European hedge funds, insurers and asset managers would have to put up “initial margin” on any trade with a US swap dealer that does not use a clearing house. At the moment, most large counterparties in over-the-counter deals are given millions of dollars of credit before they have to post anything.
Non-financial “end users” of derivatives such as Siemens or Saint-Gobain would also be caught by US rules if they wanted to transact with the local subsidiary of a US bank. Although most would not be required to post any initial margin, they would have credit limits imposed by US rules rather than their banks.
A second senior US executive said the rule would be “economically destructive” for the US as – unless Europe comes up with similar rules on a similar timetable – customers would migrate to European banks to avoid putting up cash as collateral on trades or hedging contracts.
“Deutsche Bank could do a swap with Brevan-Howard [Europe’s second-biggest hedge fund manager] and [they] don’t have to post initial margin . . . Brevan-Howard looks to [us] in London and says will you extend me the same benefit? We’d have to say ‘no’ and ‘act with us as if you’re in the United States’. That’s the central worry,” the executive said.
One bank claimed some of its customers had been approached by European rivals touting the benefits of escaping the US rules.
But the US proposals are not final and US officials say they hope that European rules will be so similar that there is no disadvantage. European and US officials said they were working on harmonisation.
But the US officials also say that it is right to include subsidiaries, the proposal says “because the US parent company’s ownership of the subsidiary is likely to expose the US parent company, as a result of legal, contractual or reputational factors, to the risks of the foreign subsidiary’s derivatives activities”.
One senior official accused banks of trying to lobby for softer rules in Europe with the aim of persuading the US to soften its proposals to avoid an unlevel playing field.
Most of the bank executives said that although the thrust of new regulations was common to the two jurisdictions, they were sceptical.
Additional reporting by Brooke Masters, Jeremy Grant and Patrick Jenkins in London
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