The Battle of Washington DC

As the debate surrounding over-the-counter (OTC) derivatives reform rages on, familiar arguments around the potential extraterritorial implications of the Dodd-Frank Act have reared their head once more, but this time from an unexpected source.

Asian regulators, concerned about the possibility of overlapping and contravening regulations for participants (and their own operations) within their jurisdictions in dealing with US entities, wrote to the Commodity Futures Trading Commission earlier this week. In the seven-page missive, they outlined what they see as too broad a definition of what constitutes a US person, unsuitability of centralized clearing arrangements in OTC markets that are too small to be of concern for systemic risk, and other areas.

Globalized Markets
The letter, signed by authorities from Australia, Singapore and Hong Kong, along with prior concerns raised by Japanese regulators, symbolizes the strongest protest over swaps reform yet from international players. Without disregarding concerns from participants, the fact that not just one, but several Asian regulators have felt the need to express their concerns in such a public manner, adds an extraordinary level of weight to arguments that have previously been raised over Dodd-Frank components such as the so-called Volcker Rule.

Whether or not the US is over reaching the limits of its proper jurisdiction, though, isn't a matter for this magazine to decide. Experts trained in international law are best left to that. However, an important question to ask is whether, by allowing cross-border transactions and encouraging multi-regional trade, regulators have left themselves open to the necessity of extraterritorial reach in financial regulation. After all, derivatives reform is mandated by the Group of 20 (G20) as a means to reduce systemic risk, following the collapse of huge players within OTC markets such as Lehman Brothers. All regulators are working on ways to centralize trading of standardized derivatives in the interests of more effective oversight. Complaining that transactions with US entities bring US legislation to bear sounds rather like attempting to close the barn door after the horse has bolted.

Definitive Definition
It's hard not to have sympathy with some concerns, though, and the Asian-Oceanian undersigned do have a point that the description of what exactly a US entity is within the proposed rules from the CFTC is very high-level. Likewise, having a sense of the pragmatic in demanding US-style central clearing in markets that pose little threat to the overall stability of the financial system is essential. Compliance costs are skyrocketing with the level of incoming regulation, particularly for those that operate in Europe, North America and Asia, and unnecessary cost should be avoided.

An important question to ask is whether, by allowing cross-border transactions and encouraging multi-regional trade, regulators have left themselves open to the necessity of extraterritorial reach in financial regulation.

Work on precision, heretofore relatively imprecise, is underway. Moves for Legal Entity Identifiers (LEIs) will help with categorization, and therefore, identification of regulatory liabilities. Centralized clearing and moves to bring standardized instruments on to exchange-like platforms will create transparency, clear audit trails and, again, fairly clear ideas of counterparty origin and national affiliation. It's just the technical details of overlap that need to be addressed.

However, there is no escaping the fact that there will be cost, and there will be reform. Whatever happens in the US presidential elections this year, anybody who genuinely believes that Romney and Ryan would tear up the Dodd-Frank Act and kick it wholesale into the grass is quite likely in for a shock. A harmonized regulatory approach to clearing, settlement, trade and other areas is essential for competitive markets to flourish in the US. With declining or stalling liquidity in many markets, diversification of not only investments, but also venues and regions is becoming increasingly important, with more and more technology back-ends geared towards such strategies.

Essentially, given the interconnectedness of modern markets, extraterritorial situations are bound to occur. Pretending otherwise is not a sensible approach, but fine tuning the inherent complexity, and creating an ordered system of oversight will allow for effective function.

If you'd like to talk legislative overlap, US regulatory imperialism, or how the mighty London Irish will almost certainly, and mercilessly, destroy Saracens at the London Double Header this weekend, send an e-mail to james.rundle@incisivemedia.com, or call on +44207 316 9811.