Warren Buffet called derivatives ‘weapons of mass financial destruction’ for a good reason. Derivatives were at the core of causing and spreading the 2008 financial crash, and one of the key lessons from that crash was that those risks are not limited by international borders. That is why U.S. taxpayers ended up bailing out both U.S. and non-U.S. banks engaged in derivatives trading in every dark corner of the world. That is also why the Dodd-Frank Act instructs the Commodity Futures Trading Commission (CFTC) to protect Americans from derivatives trading activities wherever they occur if they ‘have a direct and significant connection with activities in, or effect on, commerce of the United States.’
Unfortunately, the CFTC’s soon-to-be-finalized cross-border regulations not only fail to fulfill the objectives of that law but open avenues for evading it. The CFTC’s new regulations, if anything like the most recent proposal, will fail to protect Americans from the inevitable consequences of poorly regulated or unregulated overseas derivatives activities. Instead, they will further outsource the protection of U.S. taxpayers to foreign regulators who have failed repeatedly to protect their own taxpayers from derivatives risks.
We spelled out the technical details of the inexcusable deficiencies in the CFTC’s most recent cross-border release in our comment letter and summarized them in a related one-page document. The details are complex, but the problems are simple: The CFTC’s final regulation will seriously jeopardize the safety and soundness of U.S. banks, endanger U.S. financial stability, and put U.S. taxpayers on the hook for future bailouts of U.S. banks and others engaged in foreign derivatives dealing, all in violation of the letter and spirit of derivatives markets reforms.
These are not theoretical concerns or risks. In just the last three decades, trading by U.S. derivatives dealers through foreign vehicles and foreign off-balance sheet entities repeatedly imported risks back to U.S. banks, the U.S. financial system and U.S. taxpayers. These episodes—almost always involving regulatory arbitrage through entities organized in London or the Cayman Islands by U.S. financial firms —include the failures or near-failures of Long-Term Capital Management, Citigroup’s structured investment vehicles, Bear Stearns’ hedge funds, AIG Financial Products, and numerous foreign affiliates and branches of U.S. investment and commercial banks, like Lehman Brothers, Citigroup, and Merrill Lynch. That’s in addition to reckless London-based foreign derivatives trading inside U.S. banks, as occurred with J.P. Morgan Chase’s post-crisis ‘London Whale’ losses.
These derivatives debacles prove the old adage that ‘banks live globally, but die locally,’ meaning that in good times U.S. banks do business all over the world, but, when they get into trouble, they come back to the U.S. for support, protection and bailouts. They also prove the need for the Dodd-Frank provision requiring the CFTC to protect the U.S. from foreign derivatives dealing and risks, which the CFTC has apparently determined to unlawfully disregard.
See below updates on cross-border regulation and a collection of our past work on this issue, and stay up-to-date by signing up for our newsletter here.
Earlier this year the CFTC proposed a long overdue framework for applying the Dodd-Frank Act’s swap requirements to international activities and entities that have significant impact on the American market. While the proposal is an important step in implementing these critical regulations, many of its provisions are deeply worrying. As we explain in our fact sheet, the proposed framework would open numerous loopholes through which unscrupulous traders and firms could dodge U.S. laws. The commission is expected to vote on a finalized version of this framework at the end of July.
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The Dodd-Frank Act instructs the Commodity Futures Trading Commission (CFTC) to protect Americans from derivatives trading activities wherever they occur if they ‘have a direct and significant connection with activities in, or effect on, commerce of the United States.” Ideally, this means cooperating with our international partners to create global standards for derivatives regulation. Unfortunately, as efforts to reign in derivatives markets have stalled around the world, it has fallen to U.S. regulators to move unilaterally to ensure that American markets are stable, transparent and fair.
During the Obama administration, the financial regulators made progress, albeit limited, toward eliminating regulatory arbitrage. The CFTC overcame fierce resistance from the financial industry and issued its initial suite of cross-border regulations in 2013. While these rules only partially addressed cross-border issues, they represented a significant victory for the American people.
Unsurprisingly, the financial industry moved quickly to kill these minimal regulations. Based on a single footnote in a 300-page document, a group of powerful broker dealers claimed that U.S. personel, operating in the U.S. at U.S. banks, should be exempted from U.S. laws because they are working on behalf of overseas affiliates of those banks. The CFTC wisely rejected this preposterous argument, and in 2016, moved to strengthen its cross-borders regulation by closing loopholes through which banks avoided posting margin on derivatives trades.
Much like almost every other major reform of the post-crisis era, the CFTC’s cross-border regulations were squarely in the sights of the Trump administration’s deregulators. In a series of politically motivated proposals issued in 2019, the CFTC moved to reverse or substantially amend many of the provisions of the previous administration’s cross-border rules. In doing so, they moved to expose the American people once again to risks created by high-risk overseas gambling from which neither the American people nor the U.S. government draw any significant benefit. The most impactful of these deregulatory proposals is expected to be finalized in late July, 2020.
Better Markets Opposes the Trump Administration’s Attempt to Gut Cross-Border Rules
In 2019, the Trump administration began a full-scale assault on the CFTC’s already flawed cross-border framework. It proposed new rules and guidance that would weaken cross-border regulations, carve out massive new loopholes in rules and create an “alternative compliance framework” for certain derivatives clearing organizations that amounted to little more than unlawful exemption from U.S. laws. Better Markets pushed back against all of these proposals; in each case Better Markets was one of the few, if not the only, non-industry organizations to rigorously address the technical details of the proposal:
Better Markets continued the effort into 2020, issuing a fact sheet that concisely explained why certain elements of the proposal were not only dangerous, but also in direct violation of U.S. law.
Better Markets Guided and Supported the Initial Cross-Border Regulation Efforts
Better Markets was founded to support the reform of the financial industry initiated by the Dodd-Frank Act and part of that effort was ensuring that the financial regulatory agencies followed through on Congress’ vision for cross-border derivatives regulation. We engaged the agencies throughout the rulemaking process, from the initial policy statements to the final framework. In our comment letters, we fought back against the industries’ constantly shifting attacks on these crucial rules. Better Markets also worked to remind the agencies that despite the financial industry’s indignance, they had a legal duty to provided the markets and the American people with robust protections from overseas risk.
Cross-Border Security-Based Swap Activities; Re-Proposal of Regulation SBSR and Certain Rule and Forms Relating to the Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants 8/21/2013
Better Markets worked to support the efforts of financial reformers in the rulemaking process through media outreach that has helped keep this highly technical issue in the news.
Only Time Will Tell If the CFTC’s Future Partial Regulation of Cross-Border Derivatives Dealing Will Be Adequate to Protect the American People from Another Financial Crisis Ignited by Derivatives 7/12/2013
The financial industry actively sought to inject misinformation and bad faith claims into the cross-border regulation debate. Better Markets publicly condemned these efforts and exposed the fallacious nature of many of the arguments put forward by Wall Street surrogates. Most notably, when a European Commissioner unleashed an unprecedented public attack on the CFTC, Better Markets hit back with a scathing Op-Ed:
Better Markets Defended Cross-Boarder Regulation Against Legal Attacks
Almost as soon as the CFTC took limited steps to enforce the cross-border provisions in the Dodd-Frank Act, Wall Street’s lawyers went to work finding ways to evade them. These arguments and tactics were often highly technical and complex. Better Markets’ work in the media served not only to shine a spotlight on these flagrant attempts to avoid U.S. laws, it also helped clarify what exactly the financial industry was trying to do.
Better Markets Supports Global Efforts to Build Uniform Cross-Border Standards
The gold standard of cross-border derivatives regulation would be a uniform internal framework for managing derivatives risk. While, unfortunately, efforts to create such a standard have not been successful, Better Markets has supported cooperative committees and conferences that have laid the foundation for a truly global answer to this global problem.
Consultative Document for the Financial Stability Board on Cooperation and Information Sharing with Host Authorities of Jurisdiction Not Represented on CMGs where a G-SIFI has a Systemic Presence 12/1/2014
Other Past Activities and Materials Related to Cross-Border Rules
Applications of Commission Regulations to Swaps Between Non-Swap Dealers and Non-U.S. Swap Dealers and Non-U.S. Counterparties Involving Personnel or Agents of the Non-U.S. Swap Dealers Located in the United States 3/10/2014
Better Markets Praises CFTC for International Agreement on Clearing 2/10/2016