Britain’s Financial Services Authority, concerned that proposed new rules across the Atlantic may limit its powers, began quizzing firms last week on their plans to register as swaps dealers in the U.S., according to two people familiar with the talks.
The British agency’s role in setting capital levels may be limited for non-U.K. banks with substantial operations in London if those lenders register as swap dealers in the U.S., according to one of the people, who declined to be identified because the talks are private.
Agencies including the Commodity Futures Trading Commission have formulated rules to reduce the likelihood of a default by a major counterparty in the U.S. market for swaps. The CFTC commissioners delayed a vote on a rule defining which banks, hedge funds and energy companies would be considered swap dealers under the Dodd-Frank Act, and may take up the measure on March 20, according to a person briefed on the schedule.
“I think that the FSA and other foreign regulators are concerned about the degree of supervision the U.S. regulators are demanding for foreign banks” to deal swaps, David Felsenthal, a partner at Clifford Chance LLP in New York, said in a telephone interview.
Dodd-Frank, the U.S. regulatory overhaul enacted in 2010, required the CFTC and Securities and Exchange Commission to increase transparency in the global swaps market -- valued at $708 trillion as of June 2011 -- after largely unregulated trades of such securities helped fuel the 2008 credit crisis.
The rules being written by the SEC, CFTC and other regulators may result in companies designated as swap dealers facing higher capital and margin costs to reduce trading risks. Steven Adamske, director of public affairs at the CFTC, and Joseph Eyre, a spokesman at the FSA, both declined to comment.
The FSA is concerned disputes may arise between U.S. and U.K. regulators should a bank default on derivative contracts, said one of the people. The agency would still have oversight of capital ratios for banks domiciled in the U.K. that want to participate in the U.S. swaps market.
“There’s no easy answer for anybody,” Felsenthal said. “A lack of clarity isn’t good even for the lawyers. It is something a lot of banks have been thinking about.”
One interpretation of the CFTC’s final rule, issued last month, is that banks with branches in the U.S. would have to register the entire firm with U.S. regulators in order to trade derivatives for clients, shifting supervisory influence to the U.S. regulators.
To avoid this, banks may need to establish a swaps-focused subsidiary in the U.S., possibly adding to their cost base via higher taxes and capital requirements, Felsenthal said.
“I think we’re going to see that problem replicate itself across many aspects of the regulatory reform agenda,” Bob Penn, financial regulation partner at Allen & Overy LLP, said in a telephone interview in London. “It’s begun in derivatives and will spread to other aspects, like capital.”
Global regulators have sought tougher rules for over-the- counter derivatives since the collapse in 2008 of Lehman Brothers Holdings Inc. (LEHMQ) and the rescue of American International Group Inc. (AIG), two of the largest traders of credit-default swaps.
The Financial Stability Board, which includes regulators, central bankers and finance-ministry officials from the Group of 20 countries, warned last year that some nations may miss an end-2012 deadline for implementing agreements on OTC derivatives. There is also a risk of the G-20 rules being applied inconsistently, the FSB said.
The European Commission, the executive arm of the European Union, talks to U.S. supervisors “bilaterally, regularly and in face-to-face meetings,” on how to mesh their regulatory systems to avoid overlaps, Jonathan Faull, the EU director general for internal markets, said in a speech in London today.
JPMorgan Chase & Co. (JPM), the largest U.S. bank by assets, said interest-rate swaps and credit are among the biggest sources of revenue in its trading businesses in a presentation to investors on Feb. 28.
The bank generates $375 million from credit trading in a “typical quarter” and $350 million each from interest-rate swaps and foreign-exchange spot and futures trading.
The swaps market “isn’t constrained by natural borders,” said Mark Williams, who teaches at Boston University and wrote the 2010 book “Uncontrolled Risk,” about the fall of Lehman Brothers.
Squeezing a Balloon
Williams said swap regulation is like squeezing a balloon, where efforts to minimize risk on one side transfer the problem to the other. Without international standards, the swaps market will suffer from an “ad hoc” regulatory regime in which, for example, “if the FSA takes an aggressive approach, more swap transactions will be done in the U.S., and vice-versa,” he said in a phone interview.
For now, Dodd-Frank trumps the FSA’s standards, Williams said. Banks are learning the “level of interpretation and level of enforcement” of the U.S. law, he said. “The FSA is also motivated to take an aggressive stance on a fast-growing industry such as swaps.”
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