ISDA has long flagged the importance of harmonized derivatives rule sets, but this isn’t just a cross-border issue – it also applies on a domestic basis. Take the regulations issued by the US Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), for example. Their rules for derivatives should ideally be more or less identical, but this has been difficult to achieve in practice. Although they aim to accomplish the same outcomes, there are a number of out-and-out inconsistencies between the two rule sets, making compliance challenging. We need to find a way of dealing with this.
During recent testimony to the House Financial Services Committee, I proposed a solution to tackle this issue through a regulatory process called a safe harbor. Under this approach, a firm would be able to register as a swap dealer with the CFTC or as a security based swap dealer with the SEC, and comply with the requirements of both regulators. The safe harbor approach would effectively presume compliance with the equivalent rule set of the other agency. Rules like those on business conduct, margin and capital are so similar that the CFTC and SEC should not be concerned with allowing compliance with one set of rules.
This safe harbor approach has some important advantages – not least, it would avoid the need for firms to repeat implementation work and develop duplicative compliance systems for rules that are very similar but not necessarily identical. That just imposes extra compliance complexity and costs on derivatives users for no benefit. It also creates needless barriers to entry, and could result in market fragmentation and reduced market liquidity.
It is important to stress that a safe harbor doesn’t mean watering down derivatives market regulation, nor would it involve the CFTC and SEC relinquishing their respective jurisdiction. Both would keep general anti-fraud and anti-manipulation enforcement authority, and the respective Congressional committees would also maintain their legislative and oversight authority.
To be clear, this is all about enabling thorough but effective oversight of US derivatives markets. We think that’s very much in line with the current administration’s call for alignment, as well as being consistent with Dodd-Frank, which set regulatory efficiency and comparability between CFTC and SEC rules as a key objective.
Regulators in the US and European Union have made notable progress on cross-border harmonization, and have made substituted compliance/equivalence determinations on clearing and trade execution. It would be strange in the extreme if the US can reach such an agreement with overseas regulators, but can’t do so within its own country.