Cross-border recognition is one of those issues that tends not to get too many column inches (at least, outside of ISDA), but it is absolutely fundamental to the functioning of the derivatives market. Get it wrong, and firms face having to simultaneously comply with multiple sets of duplicative and overlapping rules, discouraging cross-border trade and resulting in market fragmentation. That means smaller liquidity pools, higher costs, less efficiency, and less resilience to market shocks.
A recent announcement by US Commodity Futures Trading Commission (CFTC) chair J. Christopher Giancarlo that a revamp of the US cross-border framework is on the cards is therefore important. Up until now, comparability assessments have been based on granular, rule-by-rule comparisons that have required overseas rules to be close to identical. The determinations are agonizingly slow, extremely complex and done on a piecemeal basis – which inevitably requires entities to comply with overseas rules in some areas but US rules in others.
We need a cross-border framework that is based on risk and recognizes overseas rules that are broadly comparable in outcomes, without requiring the rules to be exactly the same. Any changes to the current framework should reflect the progress made across the globe to implement clearing, margin, reporting and other requirements in line with Group-of-20 commitments, while respecting the fact that national regulators need to take the characteristics of their local markets and existing legal regimes into account.
ISDA has long campaigned for changes to the cross-border framework, and we proposed a risk-based approach for comparability determinations last year. As a CFTC commissioner when the cross-border guidance was released in 2013, I also opposed the extraterritorial approach taken by the agency – an approach that assumed that any trade that had some US nexus, no matter how remote, should be subject to CFTC requirements.
In unveiling a new approach, Chairman Giancarlo has recognized the problems this has caused. The proposed framework – which will be set out in a forthcoming paper – distinguishes between those rules meant to mitigate systemic risk and those reforms designed to address trading and market practices. Comparability would be required for the former, but the CFTC would exercise deference for those rules deemed sufficiently similar, based on a flexible, outcomes-based approach.
In the latter case, activities that are not risk-related – such as trading, business conduct and public reporting – could be tailored to reflect local practices and trading conditions, and would therefore fall under the oversight of the local regulator.
We think this kind of approach is more in line with the intent of US Congress to only regulate overseas activity that has a direct and significant impact on the US.
If implemented successfully, the proposed approach will provide a more efficient and consistent way of regulating derivatives markets on a global basis. As always, though, the devil is in the detail. We look forward to reviewing the paper when it is published, and engaging with the CFTC on this very important issue.
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Quantifying the Benefits of Digitization
Updating Term SOFR