Jurisdiction Battles Threaten Swaps Reform

By Colby Jenkins

Originally published on Tabb Forum 

The Securities and Exchange Commission faces ideological differences with the CFTC and international regulators in implementing Dodd-Frank reforms. But the SEC’s slow, deliberate approach to rulemaking affords the global swaps market a safer transition from opaque to transparent. 

If the Dodd-Frank Act is the cure for an unstable market, the anticipation over its implementation may be as painful as the shot. After years of missed deadlines and underwhelming progress, regulators are at a crossroads. This is the situation Mary Jo White will be walking into as the chair of the US Securities and Exchange Commission.

This past January, Elisse Walter, as chairman of the SEC, pointed to the issue of extraterritoriality as the agency’s top priority for 2013. In her words, a definitive position on cross-border regulation is “a critical linchpin” in establishing remaining Dodd-Frank compliance rules domestically and abroad. Charged with the responsibility of regulating the global market of security-based swaps, the SEC has a tremendous uphill climb in front of it -- but at least the Commission is on the right path.

Extraterritoriality is not the only jurisdictional issue facing the swaps market. In the US, Dodd-Frank regulatory responsibilities are split bilaterally between the SEC and the CFTC. This means that many market participants will need to register with both agencies. Thus, it is not surprising that recent industry-wide surveys indicate that financial institutions are not prepared -- or even taking the appropriate precautions -- to meet the requirements of impending swaps market overhaul. After all, in the face of dual-jurisdiction requirements and potentially disparate sets of compliance rules, where does one start?     

Where the CFTC has gone the route of issuing guidance with regard to cross-border regulation application (releasing this past December a final exemptive order that would afford certain global participants temporary relief from compliance obligations while the CFTC finalizes its cross-border guidance), the SEC has chosen the route of formalized rulemaking. This process will include extensive analysis as to how extraterritorial Dodd-Frank applications might affect economic factors globally and, most important, systemically  affect the U.S. financial system -- focusing in particular on the tremendous capital and margin requirements expected of a trillion-dollar industry that has previously been largely unregulated.

This slow process of regulatory overhaul is not unique to the States. Aspirations for a centrally cleared, transparent OTC marketplace are shared globally. Foreign resistance to the extraterritorial reach of the Dodd-Frank Act stems from disparities in regulatory timelines and issues of overlapping, duplicative regulation that might lead to a fragmented global market if implementation is not carried out within a framework of global coordination.

This trepidation is in many ways underscored by the blunt approach the CFTC has taken in giving global participants until May 2013 to prepare for finalized guidance on cross-border applications. On the other hand, the SEC’s approach of formally proposing rules for analysis and discussion before any regulation is finalized will likely extend an already drawn out regulatory process.

As of February 1, the SEC lagged behind the CFTC in terms of overall Dodd-Frank rulemaking progress (see Exhibit 1). With regard to Title VII progress specifically, the CFTC had finalized 35 rules and missed deadlines on eight others, while the SEC had finalized 10 rules and missed 19 deadlines (see Exhibit 2).

Exhibit 1: Overall Dodd-Frank Rulemaking Progress 

Source: Davis Polk 

Exhibit 2: Title VII Progress 

Source: Davis Polk 

While at face value the CFTC is considerably ahead of the SEC in terms of rulemaking, the progress has come at a cost. “The lawsuits and the ad-hoc barrage of exemptions point to a flawed rulemaking process that prioritized getting the rules done fast over getting them done right,” lamented CFTC commissioner Scott O’Malia, speaking at the 2013 TABB Group fixed income event.

Going forward, the CFTC will be hard pressed to thoughtfully address critical issues regarding SEFs and margin/capital requirements before the May 1 deadline. Issues such as SEF execution method flexibility, the potential for a variety of SEF platforms rather than mirror DCMs, and finalizing margin and capital rules for uncleared products that are consistent with standards set by the BCBS and IOSCO are at the top of the list.

Meanwhile, the SEC, which has 19 remaining Title VII proposals to finalize, has no such time constraint. While the idea of continued regulatory ambiguity and lethargy is certainly unappealing, creating responsible, globally reaching rules requires time for analysis, public discussion/feedback, and further refinement. When the dust settles, the SEC’s formal, stepwise approach to rulemaking will, in all likelihood, afford the global security-based swaps market a slower and safer transition from opaque to transparent.

Until then, as regulatory agencies grapple with the difficult task of internationally and domestically coordinated rulemaking, it seems the devil is in the lack of details.