Yves here. Readers may recall that Gary Gensler, the head of the Commodities Futures Trading Commission, is being pushed out by Obama. His planned replacement is so appallingly lightweight (oh, and formerly in a very junior role at Goldman) as to assure that all she’ll be able to do is take dictation from financial firm lobbyists.
But Gensler may be having a last laugh before he leaves office. The proximate reason for his ouster was that he was refusing to accede to the demands of banks and foreign regulators over implementation of Dodd Frank rules on swaps. As we wrote earlier this month:
Shahien Nasiripour at the Huffington Post describes how Gensler is being ousted for his position on swaps regulation, which was coming to a head in international meetings starting June 20, with a July 12 deadline looming. The industry was pushing for the usual “race to the bottom” approach, since the Dodd Frank provisions are more stringent than overseas requirments (the spin, of course, was that Gensler was acting unilaterally, as opposed to implementing what Congress mandated). Gensler faces varying degrees of resistance from three of his four fellow commissioners. International regulators were apparently also unhappy with Gensler’s tough stand, to the point where they were complaining to Treasury Secretary Jack Lew.
And bear in mind that the reason the banks are howling like stuck pigs is that the businesses in question are are significant profit sources. The International Financial Review gives an idea of the implications if Gensler hangs tough:
Figures from the US Treasury show that US financial institutions reported derivatives trading revenues of US$4.4bn in the fourth quarter of 2012, a 73% increase on the previous year.
These revenues were dominated by JP Morgan, Bank of America Merrill Lynch, Citigroup and Goldman Sachs. And analysts estimate that US banks route around 50% of their derivatives trades overseas, which would mean a sea change for their operations, not to mention their bottom lines, if the exemption was allowed to die.
“US banks simply aren’t ready to lose this exemption. It will cost them a considerable amount,” the first lawyer said. “Even just the logistical challenge of reorganising their trading business will be enormous, and they are likely to lose clients because of it.”
George Bailey, via e-mail, describes how Gensler is in a position to prevail in this important but largely unnoticed regulatory battle.
By George Bailey, who has worked in senior compliance roles at Big Firms You’ve Heard Of and is also a member of Occupy the SEC
Gary Gensler is under attack by the Administration, US trade negotiators, Eurocrats, the bank lobby, Congress, other regulators, and most of his fellow Commisioners for soldiering on and implementing the rules required by the Dodd Frank Act.
This fight comes to a head on July 12. That is when the CFTC’s ‘exemptive relief’ from complying with Dodd Frank rules expires for major players in the derivatives markets. If the exemption is not extended, all these players become subject to more stringent capital requirements and reporting. They’ve all assumed that the Administration would give them the waivers they wanted, or at worst water down Dodd Frank to their liking. Gensler’s refusal to back down has caught them unprepared for possible major rule changes.
The groups affected are:
Foreign branches of US banks (where > 50% of US banks derivatives activity takes place)
The International Financing Review describes the consequences for US banks:
Several sources familiar with the internal discussions at the Commodity Futures Trading Commission say that the current exemption – which allows US banks executing derivative trades outside the country to bypass tougher capital holding and reporting requirements – will be allowed to expire on July 12
“All of these common sense reforms Congress mandated … could be undone if the overseas guaranteed affiliates and branches of US persons are allowed to operate outside of these important requirements,” he (Gensler) said in a June 6 speech.
Those words shocked some who thought the extension was virtually a fait accompli.
To further complicate matters, the expiry of the exemption would effectively mean that Dodd-Frank legislation would be regulating the activity of US banks based abroad. So while European regulators obviously do not want their banks to be substantially less competitive, they also do not want the grasp of US regulators reaching into their jurisdiction.
CFTC registered foreign swap dealers may be required to comply with the full set of US CFTC rules, because their home country regulators have not kept pace and adopted comparable home country rules in time
The definition of US persons, which currently exempts US funds run out of Cayman and other offshore locations from Dodd Frank, is likely to be clarified to close that loophole, if Commisioner Chilton gets his way. In a recent speech he warned the hedge fun community to beware.
You guys from the Caymans or Connecticut may want to listen up. I don’t want to get in the way of the funds industry doing what it does best: finding opportunities for clients wherever in the world those opportunities might lie. With this and Congress’s goals in mind, here are some of my thoughts on the cross-border guidance as they relate to you guys in particular.
First, the Commission should give a clear interpretation of “principal place of business.” A firm should only have one “principal place of business.” The broader the set of factors we use to assign a “principal place of business” the more difficult it becomes to pin down where exactly is a fund’s “principal place of business.” My mantra on most of these rules is to keep it simple. Let’s focus on what really matters in clarifying this term. If there’s simply a post office box or little more, that won’t cut it as a principle place of business in my book. Where is your head office? Where are your executives and trading managers located? That’s what we need to consider.
PriceWaterhouse Coopers prepared an explainer of Dodd Frank cross border derivatives rules conflicts, for anyone looking for an accessable layman’s version of the issues involved in the current state of play.
Preparedness scheduling was predicated on the assumption that Gensler would extend the relief period. It may already be too late implement the operational changes necessary to comply with the regulations. There is a lot of anxiety on Wall Street, in DC, and in Europe.
Gensler hasn’t given any indication he intends to back down. Industry, regulators and government policy makers all expected this to have the rules finalized months ago. Instead it’s turned into a multi dimensional game of chicken. His fellow commissioners are in open revolt so concensus within the CFTC appears to be unlikely. Absent an extension, everyone will be out of compliance and in uncharted legal territory come July 12. Gensler has, so far, refused to put an extension on the agenda for a vote. He controls the agenda as Chairman.
The Europeans are so incensed they took to scolding the CFTC Chairman in an op-ed by Michel Barnier, in Bloomberg. Dennis Kelleher of Better Markets did a fine job if debunking this extraordinary display of pique.
The Bloomberg piece did serve notice to anyone who isn’t paying attention, that the gutting of Dodd Frank is scheduled to be handled in the current round of trade negotiations on financial markets. In case you missed it, here’s the money quite from Michael Barnier
Cooperation and mutual reliance, not confrontation, will protect investors and taxpayers far better than duplication and protectionism. The creation of such a binding, and mutually beneficial, framework is one of the main reasons Europe wants financial-services regulation to be included in the negotiations toward a free-trade agreement with the U.S. that begin in July.
Since the trade agreement is designed to trump the regulations (and the laws underlying them) we’d better play pretty close attention to the negotiations. Good luck with that, as Elizabeth Warren has been learning.
Yves again. This fight appears to be an alliance of US megafirms, with Rubinites leading the charge, plus undercapitalized Eurobanks. I’d welcome informed reader input, but the Brits don’t seem to be prominent in this struggle.
And it isn’t clear how this winds up. Given the refusal of the major players to prepare for the deadline, and Gensler’s control of the agenda (as in refusal to table an extension) he can dictate terms. If he does nothing, the industry will be forced into workarounds, with one of the likely results that some activity will move to regulated exchanges. That may well be Gensler’s aim, particularly since one past crisis, the LTCM meltdown, would likely not have occurred had the hedge fund been forced to conduct interest rate swaps transactions on an exchange (the hedge fund had taken an astonishing 10% of the interest rate swaps market, which was too large a position to exit gracefully, and when the rest of the Street figured out how exposed it was, they took advantage of its distress).
In the past, Gensler has gone for 11th hour compromises, but given that this is likely to be his last act, he might prove to more bloodyminded than before. Stay tuned.