by Roland Kielmanr
With less than four months to go until the G20 deadline for new over-the-counter (OTC) derivatives reforms, @DTCC spoke with Larry Thompson, DTCC Managing Director and General Counsel, about the ongoing push for international regulatory harmonization and the potential benefits of a global supervisory policy based on regulatory equivalence and mutual recognition.
Thompson recently spoke and wrote about these issues for the Financial Times Trading Room. To see the interview or read the article,“OTC rules need global harmony,” go to ft.com and search “Larry Thompson.”
Global regulatory harmonization remains a major issue among policymakers. Why is harmonization especially important in the OTC derivatives space?
The major sticking point is that, unlike the securities markets, derivatives have no set domicile – these markets and their participants are global and incredibly diverse. As a result, if new OTC derivatives frameworks are not implemented consistently across jurisdictions, regulatory gaps could develop, leaving the door open for regulatory arbitrage. So it’s important to both supervisors and market participants that rules be developed and applied uniformly across jurisdictions to ensure proper super-vision, transparency and continued competition in the derivatives space.
Secondly, global harmonization can help to ensure that we avoid circumstances where market participants are subject to multiple sets of regulatory demands from different jurisdictions. If this is not prevented, duplicative or conflicting regulatory requirements could cause legal uncertainty and contribute to some jurisdictions facing competitive disadvantages because of their regulatory environment.
This is one reason the Commodity Futures Trading Commission’s [CFTC] proposed interpretive guidance for the cross-border application of certain swaps rules is gaining so much attention from regulators and market participants outside the U.S. There are growing concerns that the broad extraterritorial reach of the Dodd-Frank Act could result in onerous regulatory requirements and higher compliance costs for the industry – costs that could be avoided if the different regimes were harmonized.
Given the vast differences between jurisdictions – both in terms of market characteristics and regional governance issues – it’s clear that regulators face a difficult challenge.
How could regulatory harmonization best be achieved?
I think regulatory harmonization can best be achieved in certain cases through a policy of equivalence and mutual recognition – that is, while rules may vary across jurisdictions, so long as the outcomes are effectively similar, third-country regulations should be recognized and accepted in place of “home-country” regulations.
Such an approach is consistent with the G20 agreement to comprehensively regulate swaps. It would also allow regulators to benefit from each national regulator’s respective regional expertise in appropriately overseeing markets within their jurisdiction.
Can you give an example of how these principles would be applied in practice?
At DTCC, we’ve frequently raised concerns about the indemnification provisions of the U.S. Dodd-Frank Act, which regulators in Europe and Asia have suggested could undermine efforts to enhance transparency into OTC derivatives markets and derail efforts at regulatory harmonization.
These provisions, which require non-U.S. regulators to indemnify U.S.-based swap data repositories before they can access data on transactions in which they have a material interest, were added to Dodd-Frank to protect the confidentiality of market data. Unfortunately, though, it has proven to be incompatible with legal structures and traditions in most jurisdictions globally.
In this case, a policy of equivalence and mutual recognition would acknowledge that local jurisdictions have legal structures and laws in place that provide an adequate and reasonable assurance of data security and confidentiality. This would mitigate the need for strict adherence to the U.S. standard and ensure that regulators continue to have access to critical market data.
Are regulators outside the U.S. supportive of the equivalence and mutual recognition policy?
Yes. A number of key regulators in Europe and Asia have publically supported this approach. The Europeans in particular have a lot of experience with it, as they already use these principles to streamline different national rules and regulations into a system that can be effectively utilized across the European Union or Eurozone.
Verena Ross, the Executive Director of the European Securities and Markets Authority [ESMA], has said that the easiest way to achieve international regulatory harmonization is through a system based on equivalence and mutual recognition. ESMA also endorsed this approach in its comment letter to the CFTC, which laid out its response to the Commission’s cross-border proposal. As an example, ESMA has already used these principles with great success in the endorsement of third-country credit-rating agencies.
Does the CFTC’s guidance provide for such an approach?
The CFTC’s proposed cross-border regime allows for “substituted compliance” in certain circumstances, although many experts have suggested that the opportunities for that approach are too limited to effectively mitigate potential regulatory overlap.
A number of other regulators, including the Hong Kong Monetary Authority, the Monetary Authority of Singapore, the Japan Financial Services Agency, the U.K. Financial Services Agency and ESMA, among others, have encouraged the CFTC to broaden the scope of the conditions under which “substituted compliance” could occur.
One of their main concerns is that substituted compliance would be applied on a case-by-case basis, rather than as an overall assessment of the regulatory regime of each relevant jurisdiction. DTCC has also encouraged the Commission to implement its substituted guidance in a manner consistent with a principle-based, regulatory recognition approach and to provide for greater reliance on the oversight of other regulators pursuing similar regulatory objectives. @