The battle over America's borders
While illegal immigration has
long been a divisive issue, an altogether different dispute has broken out over
America’s borders, this time uniting American and non-American in their attack
on new financial regulations.
The Dodd-Frank Act aims to
reform Wall Street and strengthen the country’s financial markets, but a range of
measures contained in the Act will extend the reach of this national law into
the jurisdictions of other countries, imposing extraterritorial rules on
foreign companies and threatening the liquidity of sovereign securities.
The extraterritorial reach of
the Act’s so-called Volcker rule ban on prop trading by deposit-holding
institutions, while well documented, has hitherto not been addressed to
industry satisfaction by the country’s regulatory agencies.
Fears abound that Volcker will apply
to instruments and firms outside the US if they have US connections – such as
US employees and branches – and regulatory agencies have received a barrage of complaints
from governments ranging from Canada, the UK, Europe, Japan and Mexico.
Canadian regulators have been
troubled because the Volcker rule specifically mentions Canadian bonds, fearing
their inclusion in the list of banned instruments could lead to a squeeze in
liquidity in their markets, while British lawmakers have raised concerns the
rule will make London-based markets less attractive to US firms.
This week, comments close on the
Commodity Futures Trading Commission (CFTC) version of the prop trading rule, which
mirrored a joint rule proposed in October by the Board of Governors of the
Federal Reserve System, the Federal Deposit Insurance Corporation, the Office
of the Comptroller of the Currency and the Securities and Exchange Commission
And in the main, the commentary
garnered was anti-Volcker. In a letter to the SEC last month, Tim Ryan,
president and CEO of Securities Industry and Financial Markets Association
(SIFMA), said Volcker would lead to decreased market liquidity and higher
costs, with American companies finding it more expensive to raise capital.
SIFMA is concerned the rule will
limit market making activity, decrease market liquidity across all asset
classes, raise costs for issuers, reduce returns on investments and increase
risk to corporations wishing to hedge commercial exposures.
But time seems to be running out
for any amendments to Volcker as a statute-imposed deadline for implementation
“The agencies indicate they can make the July deadline for final rules to implement Volcker, but the reality is that the rulemaking is unlikely to give companies enough time to put compliance systems in place by that time,” said Gordon Miller, Washington DC-based counsel at law firm Dechert.
But Volcker isn’t the only
extraterritorial worry in Dodd-Frank. Many believe Title VII – which provides
for regulation of OTC swaps markets – could be extensively applied
extraterritorially in ways that Congress never intended, leading to duplicative
and conflicting regulation which G20 countries intended to avoid when they
first suggested global derivatives reforms in 2009.
Aiming to bring transparency and accountability, Title VII of
Dodd-Frank requires reporting swap data throughout the lifecycle of the trade,
providing real-time dissemination of price and volume for public consumption
and to help regulators conduct market oversight. But so does the G20-endorsed European
market infrastructure regulation (Emir) and similar new laws around the world.
So how will all these new rules work together in a global marketplace?
“Such duplications and conflicts would place foreign firms
with ties to the US – both those firms headquartered abroad that choose to do
business in the US and the foreign affiliates of US firms – at a competitive
disadvantage as they conduct business around the globe,” said Chris Allen, managing
director, legal, at Barclays Capital.
Bearing witness at a House Financial Services Committee
hearing in February, Allen characterised the worldwide swaps market as robust,
with regular cross-border transactions between US and foreign entities,
including foreign branches and affiliates of US entities and US branches and
affiliates of foreign entities. But the duplication of cross-border regulation
could threaten the vibrancy of the market.
“To prevent these consequences, global entities may
effectively be forced to insulate their US business from the rest of their
global activity, significantly increasing costs and risks to firms and their
customers,” said Allen.
“Foreign regulators may choose to follow US regulators in [their
defensive] approach, imposing foreign regulations extraterritorially on purely
US activities. Such duplicative, extraterritorial regulation is in no one’s
interest,” said Allen, adding it would burden market participants by increasing
costs and fragmenting the markets.
Dr Chris Brummer, a professor at Georgetown University’s Law
Centre, told lawmakers extraterritoriality in Dodd-Frank’s swaps provisions and
duplication between jurisdictions could also cause irreconcilable compliance
He explained that while Dodd-Frank requires that swaps entered
into between parties be submitted to a clearing house registered with the CFTC
or be exempt from registration, Emir in Europe requires local clearing.
“If both rules were to be applied extraterritorially, a
cross-border swap between a US person and an EU counterparty would trigger both
jurisdictions’ clearing requirements and the swap may have to be cleared twice,”
said Brummer. “As a consequence, swap participants would potentially have to
comply with potentially duplicative or even contradictory reporting, margin and
even capital requirements.”
Brummer believed similar conflicts lay in trade repositories.
Under CFTC and SEC rules, if at least one swap participant is American, the
swap must be reported in the US, and under Emir, counterparties established in
the EU must report OTC trades to an EU-registered repository.
No good for anyone
Don Thompson, associate general counsel at JPMorgan Chase
& Co, believed the extraterritorial application of Title VII’s proposed
margin rules for uncleared swaps will place US firms at a distinct competitive
disadvantage in the global marketplace.
“If a French pension fund, a Dutch company or an Asian
sovereign wealth fund wishes to enter into a derivatives transaction, European
or Asian banks will not require them to post margin. If Dodd-Frank is read to
require US banks to do so, we will simply lose this business,” said Thompson,
explaining that since most companies seeking debt underwriting require a
derivative as part of their funding plan – like a German firm wishing to issue
debt in dollars and swap to euros – Title VII would inhibit the US competing in
“The competitive impact of applying the margin rules to our
swap activities overseas is exacerbated by very prescriptive and restrictive
rules governing what types of margin are eligible under the proposed regime,”
said Thompson. “By restricting eligible margin to US dollar cash or treasuries,
the proposed rules will not only put US banks in the position of demanding
margin from our overseas clients when our competitors do not, but we would not
even be permitted to accept margin in the form of, for example, euro cash and
G7 sovereign debt, which are common forms of permitted collateral in European
The effect of this, argued Thompson, will be to eviscerate American
firms’ ability to serve clients overseas and cede the global market to foreign
competitors, who would not be subject to these rules.
“If Title VII applies only to international branches of US
banks serving European or Asian clients, but not to our European or Asian
competitors, we will lose much of this business. The impact on J.P. Morgan
would be severe,” said Thompson, explaining that although it varied from
quarter-to-quarter, the firm often derives as much of its revenues from its global
operations as it did from those in the US. “Losing our non-US customers would
deprive us of valuable diversification in our credit exposures and would
increase risk to our firm rather than reduce it.”
Congress is presently reviewing both Volcker and Title VII and
many industry players doubt Volcker will be implemented on schedule by July.
Between now and then, many a Washington lobbyist will be kept busy trying to
sway regulators and the Hill that Dodd-Frank needs no extra territoriality.