http://www.reuters.com/article/2013/08/12/markets-credit-idUSL2N0GD1JA20130812
NEW YORK, Aug 12 (IFR) – US banks are at risk of losing overseas swaps market share as European clients have begun making every effort to avoid getting caught up in costly cross-border derivatives rules that were finalised by the CFTC last month, and come into effect this October.
European hedge fund and asset managers are threatening to transfer their swaps trading activities away from branches of US banks and towards European competitor houses to ensure they avoid the reaches of Dodd-Frank, which mandates an array of costly compliance measures, including the central clearing of standardised over-the-counter derivatives.
Many European clients would rather ditch their US bank relationships than bear that cost – just one of the unintended consequences of bad rule-writing according to dealers.
“It’s the one rule that risks the most competitive disadvantage,” said a lawyer at a US dealer. “There’s no way these clients are going to clear with us at this stage.”
Swaps executed by a European client with the foreign branch of a US bank will be required to clear through a central counterparty starting on October 9 – the date that an exemption from compliance with the CFTC’s recently finalised cross-border guidance will expire.
US banks say the deadline is unreasonable and compliance will be near-impossible. And at least one of the CFTC commissioners sympathises.
“My frustration has consistently been with the Commission establishing arbitrary dates that we pluck out of thin air to establish compliance without asking, ‘is this possible?'” said CFTC commissioner Scott O’Malia.
“The cross-border guidance should have required notice and a comment period to find out if the time periods for compliance are adequate. We claim to be having a comment period but I suspect that anyone who does so will have their comments completely ignored.”
Conversely, the October clearing deadline comes two months before the CFTC forces US branches to comply with the rest of the agency’s transaction-level requirements, such as trade execution, documentation, and real-time public reporting.
“The CFTC is asking us to pull a rabbit out of a hat,” said an executive at the London branch of a US bank. “They have offered ‘substituted compliance’ but the European rules are not even done yet. Nobody in their right mind thinks we can demonstrate substituted compliance by the deadline.”
AFFILIATED ALTERNATIVE
For end-user clients, mandatory clearing can be a costly business. Clients must negotiate and document relationships with clearing houses and clearing member banks, and are required to post initial margin against all swaps that are passed through the system.
The CFTC guidance provides that foreign branches of US banks could apply to substitute their home country compliance for US rules in cases such as these if the rules were considered “comparable and comprehensive”.
It is likely to be the longer-term answer for most European branches of US houses, but the European rules for clearing are not yet finalised, leaving nothing concrete for comparison.
Some banks are moving to plan B, which involves transferring all client relationships from their foreign branches to affiliates – a separate legal entity that would protect European funds from the clearing mandate.
But that would not be easy, considering that firms such as JP Morgan have more than 10,000 clients booked through their UK branches.
“There are a number of impediments; it’s very difficult to move clients to another legal entity. Plus, many of those affiliates have regulators of their own who will raise concerns about wholesale transfers of clients,” said the lawyer.
NO-ACTION REQUEST
US banks say they have sent the Commission requests for an extension to the deadline, by way of no-action relief or some other format. Given the Commission’s penchant for issuing no-action relief – the agency has issued more than 100 in connection with Dodd-Frank to date, a pushback of the compliance date seems possible – if not likely.
If history is anything to go by, the CFTC is likely to keep the industry in suspense until the eleventh hour.
“There’s no rhyme or reason for how the no-actions are issued,” said O’Malia. “It creates a confusing ad hoc process that leaves a lot of people trying to understand a lot of moving parts when we are not following the Administrative Procedure Act. We’re using and abusing the no-action relief system.”
The development represents another trough in the often tumultuous process of aligning cross-border implementation of new rules for the OTC derivatives market between Europe and the US.
For the past two years, US banks have been warning that the CFTC’s hurried pace in implementing the rules of Dodd-Frank would put US dealers at a competitive disadvantage.
Just over a year ago, the agency issued proposals that would have forced branches of US banks to comply with all transaction-level requirements in July of this year.
But European entities and US lawmakers levied heavy criticism of CFTC chairman Gary Gensler’s approach to international harmonisation of derivatives rules.
In response, Gensler pledged closer co-ordination with European regulators in a joint statement with the EC’s internal market and services commissioner Michel Barnier just before the original proposals were due to take effect.
The scaled-back proposal reduced the CFTC’s powers in determining whether foreign regulations could be substituted for US rules and issued no-action relief for most requirements until European regulators could catch up.
But the proposal may still have over-reached, according to banks. Whether the US banks are able to move their clients over to affiliates in time or the agency issues a no-action relief remains to be seen, but for the moment banks are facing a significant cross-border dislocation.
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