Gensler reflects on US regulatory reform

“For the first time, we have in place a legal and regulatory foundation for the vast swaps markets that brings transparency and lowers risk for the American public,” began Gary Gensler, chairman of the CFTC (Commodities Futures Trading Commission). “This new comprehensive regulatory regime includes robust rules of the road to benefit those who trade swaps as well as those who have never even heard of them.”

The breadth of reform, not just in America, but globally, has been vast. Only time will tell how well the reforms implemented over the past few years will safeguard the future. Risk never disappears completely and is sure to rear up in unexpected places in the future.

For now, however, Gensler and the CFTC have almost completed the implementation of the 2010 Dodd-Frank Act. Their goal was to safeguard their own interests, those of the USA. As a result of taking a lead on the rest of the world and pushing ahead with its reforms, the only reformatory issues that remain for the CFTC in the OTC derivatives space is on a global level.

Of this Gensler stated the following: “Congress was clear that the far-flung operations of U.S. enterprises are to be covered by reform. Recognizing the lessons of the crisis and modern finance, Congress was clear in section 722(d) of the Dodd-Frank Act that swaps reform does apply to activities outside our borders with ‘a direct and significant connection with activities in, or effect on, commerce of the United States.’

“The largest banks and institutions are global in nature, and when a run starts on any part of an overseas affiliate or branch of a modern financial institution, risk comes crashing right back to our shores. The nature of modern finance is that financial institutions commonly set up hundreds, or even thousands, of legal entities around the globe. In fact, the U.S.’s largest banks each have somewhere between 2,000 and 3,000 legal entities. AIG nearly brought down the U.S. economy because it guaranteed the losses of a Mayfair Branch operating under a French bank license in London. Lehman Brothers had 3,300 legal entities, including a London affiliate that was guaranteed here in the U.S., and it had 130,000 outstanding swap transactions. Citigroup had structured investment vehicles that were set up in the Cayman Islands, run out of London, and yet were central to not one, but two bailouts of that institution. Bear Stearns, in 2007 had two sinking hedge funds organized in the Cayman Islands that had to be bailed out by the parent entity. A decade earlier, the same was true for Long-Term Capital Management.

“After receiving public input and coordinating with the SEC (Securities Exchange Commission) and other regulators, working with international regulators, we issued guidance and an exemptive order to provide clarity to the market that our new rules apply to cross-border derivative activities. The CFTC interprets the cross-border provisions to cover swaps between non-U.S. swap dealers and guaranteed affiliates of U.S. persons as well as swaps between two guaranteed affiliates. The guidance does recognize and embrace the concept of substituted compliances where there are comparable and comprehensive rules abroad. Further, the interpretive guidance captures offshore hedge funds and collective investment vehicles that have their principal place of business here in the U.S. or that are majority owned by U.S. persons.

“We published the proposed guidance for public comment in June of last year and then sought additional comment in December. On July 12, we gave swap dealers organized in each of six jurisdictions (Australia, Canada, the European Union, Hong Kong, Japan and Switzerland) five additional months to come into compliance with certain swaps reforms as we assess the submissions from those jurisdictions regarding substituted compliance.”

It hints at Gensler’s own position on the subject of substituted compliance, or regulatory equivalency to use European parlance, that the CFTC should have been more draconian in its scope. The objection to this came from within the CFTC and from the American banks with overseas operations, not to mention regulators in Europe.

Our coverage of substiuted compliance:

It’s not too late, of course. The exemption upon foreign swap dealers was only extended for five months. This at least offers breathing space to the regulators and banks in question. It does, however, remain as a massive hurdle to overcome along the road to reform of the previously unregulated swaps market.

Gensler concluded: “The CFTC, having completed 59 final rules, orders and guidances, has nearly completed the rule set, and market participants are coming into compliance with these reforms. Clearinghouses have begun clearing the majority of interest rate and credit index derivatives, and the biggest swap dealers have provisionally registered with the CFTC. The public and regulators are benefitting from transparency, as real time and regulatory reporting is already a reality. SEFs (swap execution facilities) will be up and running soon.

“I am pleased to tell you that the swaps market, which once was an unregulated highway, now has streetlights and traffic laws. The dealers now have to have drivers’ licenses. Though there is still critical work to be done, the swaps marketplace will no longer be dark and will now have safer roads. Still, our traffic laws will not be fully effective without a sufficient number of cops patrolling the highways and back roads.”

You can read Gary Gensler's testimony in full here:

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