CFTC Scales Back Oversight of Cross-Border Swaps Trading - The Wall Street Journal

‘It’s unnecessary for the CFTC to essentially be the world’s policeman for all swaps,’ said CFTC Chairman Heath Tarbert.

Photo: Evan Agostini/Associated Press

By

Dave Michaels

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• @davidamichaels

Updated July 23, 2020 5:51 pm ET

The U.S. derivatives regulator on Thursday voted to abandon its effort to regulate trading that happens overseas, where it had worried that interconnections between big banks in the global market could transmit risk to the U.S. economy.

The Commodity Futures Trading Commission’s plan will effectively cede oversight of that activity to overseas regulators whose rules are deemed sufficient. The plan, which passed along party lines on a 3-2 vote, represents a win for banks such as JPMorgan Chase & Co. and Citigroup Inc. that dominate the $558 trillion global swaps market and have structured their trading in places like London to minimize U.S. oversight.

Thursday’s measure is deregulatory, CFTC Chairman Heath Tarbert said, but it is justified by developments that occurred since the U.S. sought to impose its rule framework on cross-border trades seven years ago.

“It’s unnecessary for the CFTC to essentially be the world’s policeman for all swaps,” Mr. Tarbert, a Republican, said during Thursday’s meeting.

The CFTC’s earlier efforts to regulate overseas trading, based on guidelines issued during the Obama administration, targeted cases where a bank or other company based in the U.S. was on the hook for a foreign affiliate’s losses. Swaps traded by American International Group through a London subsidiary were at the heart of AIG’s $182 billion bailout in 2008, and London-based swaps trading in 2012 cost JPMorgan over $6 billion.

Banks in recent years stopped overtly guaranteeing their affiliates’ trades, although regulators acknowledge that a parent company may for reputational and other reasons assume the risk incurred by overseas affiliates or branches. The CFTC’s final rule includes a narrower definition of guarantee that doesn’t include types of financial support which “transfer risk directly back to the U.S. financial system,” as the agency said in its December 2019 proposal.

The CFTC also won’t regulate trades handled or negotiated by bank employees in New York or other U.S. cities as long as the trade is booked into an overseas entity and not done with a U.S. counterparty.

CFTC officials said the new approach accounts for Europe, Japan and other jurisdictions having passed their own rules to oversee derivatives that were unregulated before the 2008 financial crisis. The U.S. moved to supervise swaps trading and require more transparency in the market through the 2010 Dodd Frank Act.

“When you look at a lot of the major money center jurisdictions—the EU and Japan and other places in Asia—there is very good alignment and very good comparability,” Joshua Sterling, the director of the CFTC’s division of swap dealer oversight, said in an interview.

Deferring now to overseas regulators who have set up their own rules doesn’t “weaken oversight or protections of our market,” said Republican Commissioner Dawn Stump.

Democrats on the five-member commission voted against the rule, saying the agency is renouncing an approach that has worked and that banks have had years to adopt.

“It unavoidably leaves risky activities unregulated that due to the interconnectedness of global markets individually, and in the aggregate, can and likely will negatively impact U.S. markets,” said Commissioner Rostin Behnam, a Democratic member.

The CFTC’s approach will only capture overseas trading if the risk taken by the affiliate booking the swap is guaranteed “in writing” by the parent, said Dan Berkovitz, a Democratic commissioner.

“If the trigger for the application of Dodd-Frank [rules] is a formal written guarantee, they’re not going to do that, but they’re guaranteed just the same,” he said.

Thursday’s meeting included testy moments when Republican and Democratic members clashed over whether the CFTC under Mr. Tarbert has eased oversight too much. The commission has voted over the past year to advance many rulemakings that stalled under prior chairmen. The agency on Wednesday voted 3-2 to pass capital requirements for swaps dealers.

“We heard a lot about how yesterday’s and today’s rules were rolling back protections or threaten progress,” said Republican Commissioner Brian Quintenz. “Absolutely absurd theories, commentaries, language, labels, accusations, were thrown around with no substantiated evidence or examples.”

The fight over how far overseas the CFTC—one of the smallest U.S. financial regulators—can go to regulate swaps trading dates to 2013, when associations representing banks such as Goldman Sachs Group Inc. and JPMorgan sued the agency. The CFTC mostly prevailed in the lawsuit, but even pro-regulation groups said the reliance on guidelines, and not more permanent rules that are passed after public feedback, wasn’t sustainable.

Write to Dave Michaels at dave.michaels@wsj.com

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