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Swiping at Swaps

February 9, 2012

Photo by J. Thomas Shaw. Some right reserved.

This week, the financial services industry and Congress took swipes at the SEC’s and CFTC’s efforts to implement the Dodd-Frank Act’s provisions concerning swap transactions.

On February 7th, the International Swaps and Derivatives Association (“ISDA”) and the Securities Industry and Financial Markets Association (“SIFMA”) filed an application to preliminarily enjoin enforcement of the CFTC’s position limits for swaps. The motion was filed in the groups’ lawsuit challenging the propriety of the CFTC’s rule.

The lawsuit alleges that the CFTC failed to find, as allegedly required by the Commodity Exchange Act, that the new position limits were necessary or appropriate. The ISDA and SIFMA further claim that the CFTC’s rulemaking failed to include the cost-benefit analysis demanded by the Administrative Procedures Act. 

While the ISDA’s and SIFMA’s arguments on why they are likely to succeed appear meritorious, their claims concerning irreparable harm are less convincing. In the rule’s adopting release, the CFTC states that traders will not be required to comply with the position limits for swaps until 60 days after the CFTC and SEC adopt rules defining what will be considered a swap. And since neither agency has publicly stated when “swap” might be defined, the irreparable harm caused by enforcement appears speculative.

Congressional swipes at the agency’s swap rulemaking occurred on February 8th when the House Capital Markets Subcommittee held hearings entitled “Limiting the Extraterritorial Impact of Title VII of the Dodd-Frank Act.” See the Hearing Website (with links to archived webcast and witness’ prepared statements).

Last May, Blogmosaic discussed how the regulation of swaps posed extraterritorial questions on an entity-level (do foreign firms have to register their U.S. subsidiaries in the U.S.?), and on a transaction-level (is the trade subject to U.S. law?). We noted that the CFTC’s proposed entity swap registration rule considers the use of the U.S. mail (or “instrumentality of interstate commerce”) as a factor in determining whether sufficient U.S. contacts exist to require the application of U.S. law.

In October, Congressman James Himes introduced H.R. 3283, the “Swap Jurisdiction Certainty Act,” in an effort to answer the extraterritoriality question.

Georgetown University law professor Chris Brummer summarized the bill:

U.S. registered swap dealers engaging in swap transactions with a non-U.S. person would not be subject to the Dodd-Frank derivatives rules if each party reports the swap to an SEC registered swap repository. Meanwhile, under the second avenue, a non-U.S. person that registers as a swap dealer or security-based swap dealer with the CFTC or SEC, respectively, can be deemed to have satisfied Dodd-Frank capital requirements by complying with comparable regulatory requirements in the firm’s home country, so long as such home country is a signatory to the Basel Accords. The first provision thus constitutes a carve out, and the second, a gateway for future greater regulatory acknowledgement and deference through a mutual recognition regime.

Brummer notes that the proposed legislation does not provide for prudential regulation. It is simply meant as a surveillance mechanism.

And for U.S. regulators, surveillance might prove the most prudent way to swipe at swaps.

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