OTC Market Transparency in Danger
By Dan Cohen
Originally published on Tabb Forum
The extraterritorial reach of new financial rules in the United States has risen to a global level of attention — and based on the level of concern among policymakers and financial institutions here and abroad, it’s going to remain prominent for the foreseeable future.
Treasury Secretary Timothy Geithner highlighted the need to resolve extraterritorial issues and warned of the potential for regulatory arbitrage during a recent press conference. The Commodity Futures Trading Commission and Securities and Exchange Commission weighed in on the topic as well with a joint report that acknowledged gaps may exist in the new global regulatory framework. The House Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises put a microscope to the issue at a Feb. 8 hearing that focused on limiting the adverse extraterritorial effect of new derivatives rules resulting from the Dodd-Frank Act.
The cause of concern is the application and reach of new financial rules across jurisdictions and borders and the extent to which these regulations will apply to the U.S. operations of foreign firms and vice versa.
Extraterritoriality has been a priority since Dodd-Frank passed in 2010 because two provisions in the law could have the unintended consequence of reducing transparency into OTC derivatives markets.
The new regulatory structure requires swap data repositories, which are the key to enhancing transparency, to provide the SEC and the CFTC with plenary access to all data that it collects and maintains — even if that data falls outside the scope of U.S. jurisdiction.
The law also requires U.S.-based SDRs to receive a written indemnification agreement from non-U.S. regulators confirming they will abide by confidentiality requirements and indemnify the SDR and the regulating agency for any expenses arising from litigation relating to the information.
The extraterritorial reach of these provisions would give, for example, U.S. regulators the legal right to review data on a trade between two British banks transacting in the United Kingdom involving a British underlying entity — even though the United States has no material interest in that transaction. Furthermore, the British regulator would also be required under Dodd-Frank to indemnify the U.S. SDR to gain access to that same data.
These provisions are fundamentally flawed. The provisions fail to recognize foreign legal systems — many of which are unable or unwilling to enter into such agreements — or the inability of the U.S. to accept reciprocal demands from foreign entities.
Moreover, these provisions run contrary to data sharing guidelines already developed by the OTC Derivatives Regulators Forum and in use by repositories throughout the world, including the Depository Trust and Clearing Corp.’s Global Trade Repository for credit default swaps.
Under these guidelines, regulators must maintain the confidentiality of information they obtain from trade repositories and affirm that the information is of material interest to their oversight.
The thicket of new regulations being drafted in the U.S., Europe and Asia have the potential not only of creating an unlevel playing field but of impeding global regulatory cooperation and undermining efforts to increase market transparency and mitigate risk in the over-the-counter derivatives market.
Many regulators worldwide have expressed deep concerns that the provision may force jurisdictions outside the U.S. to establish their own “national” repositories to avoid indemnification. This would fragment the current global data set and limit the ability of regulators worldwide to obtain a comprehensive view of market activity.
Recognizing this risk, foreign jurisdictions have widely rejected the Dodd-Frank approach. For example, European lawmakers did not include an indemnification requirement in its derivatives reform package, known as European Market Infrastructure Regulation.
The unintended consequences of indemnification and plenary access have gained considerable attention among U.S. lawmakers. There now appears to be broad bipartisan and bicameral support in Congress for a legislative measure to correct these technical drafting errors.
With concerns over extraterritoriality growing here and overseas, Congress must act to ensure that regulators continue to have access to as much information tomorrow as they do today.