CFTC Under Fire from Asia-Pacific Regulators

The US Commodity Futures Trading Commission (CFTC) has been criticized by Asian regulators over the potential reach of over-the-counter (OTC) derivatives legislation.

In a letter sent to the CFTC, the bodies argued that OTC trading reform in the US, enacted primarily through Title VII of the Dodd-Frank Act, has extra-territorial implications for their organizations as well as market participants, and could create complexity, cost, fragmentation and risk in international markets.

While the letter notes that Group of Twenty (G20) mandates mean OTC derivatives reform is taking place on a global basis, concerns over provisions for clearing and other areas could mean, they suggest, overlapping and contravening legislation in other nations that deal with US institutions.

"We are concerned that some of the proposed requirements as they currently stand may have significant effects on financial markets and institutions outside of the US," said the group. "We believe a failure to address these concerns could have unintended consequences, including increasing market fragmentation and, potentially, systemic risk in these markets, as well as unduly increasing the compliance burden on industry and regulators."

Risky Definitions
The signatories included senior representatives from the Australian Securities and Investments Commission, the Reserve Bank of Australia, the Hong Kong Monetary Authority, the Hong Kong Securities and Futures Commission and the Monetary Authority of Singapore.

This is a large grouping of regionally-strong regulatory bodies, and added to the concerns raised with the CFTC earlier in the month by Japan's Financial Services Authority, creates a strong Asian front against regulatory over-reach.

The group stated that they welcomed CFTC efforts to facilitate cross-border regulatory cohesion, however, they noted that the definition of a US entity, as noted in the regulation, was particularly ambiguous and overly applicable to many persons. Dealings with persons or institutions deemed to be US-based, under many of the rules in the Act, make counterparties subject to compliance with Dodd-Frank and US regulatory bodies.

"We believe the Proposed Guidance would benefit from greater clarity and detail regarding the application of the swap provisions," they said. "In particular, (a) the definition of 'US person'; and (b) the criteria, procedures and implementation timeline for 'substituted compliance' in respect of each of the CFTC's entity-level requirements and transaction-level requirements could each be further clarified.

"We would welcome dialogue with the CFTC on these areas.
We note that the proposed definition of 'US person' is high-level and different from that used in other regulations (eg. Reg S). Market practitioners have also highlighted that it is not easy to identify if a counterparty is a US person. Uncertainty will increase the risk for, and costs of, market participants in assessing the full impact of the Proposed Guidance (eg. the registration requirements)," they continued.

Proposals from their part included a re-assessment of the timescale for implementation, more clarity on the definition of a US person, further exemptive relief for non-US entities from the proposed guidance, and proportional regulatory approaches to central clearing in non-US jurisdictions with relatively small OTC markets.

Over-reach
The letter marks one of the more serious concerns raised about potential extra-territorial implications inherent within the Dodd-Frank Act. Similar issues have been raised in the past by participants, or lawyers acting for them, regarding other provisions within the Act, such as the so-called Volcker Rule. This is, however, a large grouping of regionally-strong regulatory bodies, and added to the concerns raised with the CFTC earlier in the month by Japan's Financial Services Authority, creates a strong Asian front against regulatory over-reach.

However, the CFTC has been working on a program of identification and definition with regards its derivatives rules of late. Recently, it released what it considers various market terms, such as swap dealers, to constitute, thereby clarifying to what extent regulatory compliance will effect participants. It has also identified specific contracts in various asset classes that are eligible for clearing through central counterparties (CCPs) under Dodd-Frank.

The Bottom Line

• Concerns over the extra-territorial applications of the Dodd-Frank Act, and the resultant compliance costs and legislative complexity that creates for both participants and regulators, continue to grow.
• This letter, along with the JFSA's concerns, presents a serious challenge for the CFTC, coming from fellow regulatory bodies rather than regulated entities.
• More than anything, in an increasingly inter-connected world, this letter serves to highlight the importance of cohesive regulatory strategy between regional bodies.