WASHINGTON (CN) - The Commodity Futures Trading Commission decided on Friday that its swap market rules, mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, should apply to foreign swap transactions that have U.S. counterparties or are backed by domestic firms.
In a closed session, the commission voted to approve a proposed guidance that would require registration of all swap transactions involving U.S. counterparties or that were initiated by foreign branches of U.S. firms or affiliates that are guaranteed by a U.S. entity.
This broad application of the transaction level requirements comes after months of hard campaigning by CFTC Chairman Gary Gensler to expand cross-border application of the swap rules.
In a statement Gensler said the rules were necessary to protect the U.S. financial system against foreign risks.
"During a default or crisis, the risk that builds up offshore inevitably comes crashing back onto U.S. shores," Gensler said. He cited the recent examples of Bear Stearns, Leheman Brothers, AIG, Citigroup and JPMorgan Chase, all of whom suffered massive, potentially destabilizing losses that began with trades initiated either in London or the Cayman Islands.
Though approval was unanimous, the fact that the commission will accept public comments on the guidance which it is not required to do, and that voting was delayed by more than a week indicated disagreement among the five commissioners.
Indeed, Commissioner Scott O'Malia said in a concurring statement that his yes vote was provisional pending changes likely to be recommended during the public review period.
"After the comment period, the Commission will review public comments and subsequently will incorporate those comments into final guidance. I would like to make it clear that if I were asked to vote on the Proposed Guidance as final, my vote would be no."
O'Malia and fellow Republican appointee Jill E. Sommers said that the cross-border application of the swaps rules ignores international law and is poorly coordinated with similar attempts to regulate U.S. facing risk by other domestic regulators like the Securities and Exchange Commission.
The proposed guidance does allow for "substituted compliance" where dealers and market participants can claim exemption for U.S. swap regulation if they can show that they are subject to comparable regulation in their home jurisdiction.
Sommers said that this provision was still too vague but was better then previous versions of the guidance which would have applied to all transactions involving a U.S. person without recourse to substituted compliance. Sommers had called such a blanket application of U.S. rules to foreign entities "nothing short of extra-statutory and extra-constitutional."
The guidance breaks compliance into to tiers. Transaction level compliance governs each trade with regard to clearing, margin, real-time public reporting, trade execution, trading documentation and sales practices.
Entity level requirements govern entire firms that meet trading thresholds for registering with the CFTC. These include minimum capital reserves, appointment of a chief compliance officer, swap data recordkeeping, reporting to swap data repositories and large trader reporting.
Offshore subsidiaries and affiliates of U.S. firms will have to comply with both the transaction and entity level requirements unless they can show comparable regulation by foreign regulators.
Under the guidance, foreign firms, unaffiliated with a domestic entity, would have to register with the CFTC if they engage in trades involving U.S. counterparties that would require a U.S. dealer or market participant to register.
The commission said this de minimis requirement satisfies the threshold set by Dodd-Frank limiting cross-border application to activities that "have a direct and significant connection with activities in, or effect on, commerce of the United States."
The public comment period will last 45 days and begins after the proposed guidance is published in the Federal Register, probably sometime this week.