President John Adams once warned: “Great is the guilt of unnecessary war.”[1] While he was obviously referring to military conflicts, his admonition applies to conflicts among nations more generally. Financial regulation has not been exempt from international discord. And in recent years, the CFTC’s own cross-border guidance on swaps has caused concerns about a regulatory arms race and the balkanization of global financial markets. Consider the following entreaties by our overseas allies and regulatory counterparts:

“At a time of highly fragile economic growth, we believe that it is critical to avoid taking steps that risk withdrawal from global financial markets into inevitably less efficient regional or national markets.”

– Letter from the Finance Ministers of the United Kingdom, France, Japan, and the European Commission to CFTC Chairman regarding the CFTC’s cross-border guidance (Oct. 17, 2012)

“We believe a failure to address [our] concerns could have unintended consequences, including increasing market fragmentation and, potentially, systemic risk in these markets, as well as unduly increasing the compliance burden on industry and regulators.”

– Letter from the Australian Securities and Investments Commission, the Hong Kong Monetary Authority, the Monetary Authority of Singapore, the Reserve Bank of Australia, and the Securities and Futures Commission of Hong Kong to CFTC Chairman regarding the CFTC’s cross-border guidance (Aug. 27, 2012)

“… [U]sing personnel or agents located in the U.S. would not be a sufficient criterion supporting the duplication of applicable sets of rules to transactions [between non-U.S. persons,] and [we] ask you to consider not directly applying rules on this basis.”

– Letter from Steven Maijoor, Chair, European Securities and Markets Authority to Acting CFTC Chairman regarding the CFTC staff’s “ANE Advisory,” No. 13-69 (Mar. 13, 2014)

I will leave it to others to debate whether the international discord caused by the CFTC’s cross-border guidance[2] and related staff advisory[3] was “necessary” at the time it was introduced. Far more constructive is for us to ask whether it is necessary today. For me, there is but one conclusion: Because nearly all G20 jurisdictions have adopted similar swaps regulations pursuant to the Pittsburgh Accords,[4] it is unnecessary for the CFTC to be the world’s policeman for all swaps.

On this basis, I am pleased to support the Commission’s final rule on the cross-border application of registration thresholds and certain requirements for swap dealers and major swap participants (“swap entities”). This final rule provides critically needed regulatory certainty to the global swaps markets. And I believe it properly balances protection of our national interests with appropriate deference to international counterparts.

Need for Rule-Based Finality

As noted above, the Commission’s 2013 Guidance left much to be desired by both our market participants and our regulatory colleagues overseas. The action was taken outside the standard rulemaking process under the Administrative Procedure Act,[5] so was merely “guidance” that is not technically enforceable. But because market participants as a practical matter followed it nonetheless, it had a sweeping impact on the global swaps markets. Over the intervening years, a patchwork of staff advisories and no-action letters has supplemented the 2013 Guidance. With almost seven years of experience, it is high time for the Commission to bring finality to the issues the 2013 Guidance and its progeny sought to address.

Congressional Mandate

We call this final rule a “cross-border” rule, and in certain respects it is. For example, the rule addresses when non-U.S. persons must count dealing swaps with U.S. persons, including foreign branches of American banks, toward the de minimis threshold in our swap dealer definition. More fundamentally, however, the rule answers a basic question: What swap dealing activity outside the United States should trigger CFTC registration and other requirements?

To answer this question, we must turn to section 2(i) of the Commodity Exchange Act (“CEA”),[6] a provision Congress added in Title VII of the Dodd-Frank Act. Section 2(i) provides that the CEA does not apply to swaps activities outside the United States except in two circumstances: (1) where activities have a “direct and significant connection with activities in, or effect on, commerce of the United States” or (2) where they run afoul of the Commission’s rules or regulations that prevent evasion of Title VII. Section 2(i) evidences Congress’s clear intent for the U.S. swaps regulatory regime to stop at the water’s edge, except where foreign activities either are closely and meaningfully related to U.S. markets or are vehicles to evade our laws and regulations.

I believe the final rule we issue today is a levelheaded approach to the exterritorial application of our swap dealer registration regime and related requirements, and it fully implements the congressional mandate in section 2(i). At the same time, it acknowledges the important role played by the CFTC’s domestic and international counterparts in regulating parts of the global swaps markets. In short, the final rule employs neither a full-throated “intergalactic commerce clause”[7] nor an isolationist mentality. It is thoughtful and balanced, and it will avoid future unnecessary conflicts among regulators.

Guiding Principles for Regulating Foreign Activities

As I have stated before,[8] I am guided by three additional principles in considering the extent to which the CFTC should make use of our extraterritorial powers.

1. Protect the National Interest

An important role of the CFTC is to protect and advance the interests of the United States. In this regard, Congress provided the CFTC with explicit extraterritorial power to safeguard the U.S. financial system where swaps activities are concerned.

It is incumbent upon us to guard against risks created outside the United States flowing back into our country. But our focus cannot be on all risks. Congress made that clear in section 2(i). It would be a markedly poor use of American taxpayers’ dollars to regulate swaps activities in far-flung lands simply to prevent every risk that might have a nexus to the United States. It would also divert the CFTC from channeling our resources where they matter the most: to our own markets and participants. The rule therefore focuses on instances where material risks from abroad are most likely to come back to the United States and where no one but the CFTC is responsible for those risks.

Hence, guarantees of offshore swaps by U.S. parent companies are counted toward our registration requirements because that risk is effectively underwritten and borne in the United States. The same is true with the concept of a “significant risk subsidiary” (“SRS”). As explained in the rule, an SRS is a large non-U.S. subsidiary of a large U.S. company that deals in swaps outside the United States but (1) is not subject to comparable capital and margin requirements in its home country, and (2) is not a subsidiary of a holding company subject to consolidated supervision by an American regulator, namely the Federal Reserve Board. Our final cross-border rule requires an SRS to register as a swap dealer or major swap participant with the CFTC if the SRS exceeds the same registration thresholds as a U.S. firm operating within the United States. The national interest demands it.[9]

2. Follow Kant’s Categorical Imperative

As I said when we proposed this rule, I believe cross-border rulemaking should follow Kant’s “categorical imperative”: we should act according to the maxim that we wish all other rational people to follow, as if it were a universal law.[10]

What I take from that is that we should ourselves establish a regulatory regime that we believe should be the global convention. How would this work? Let me start by explaining how it would not work. If we impose our regulations on non-U.S. persons whenever they have a remote nexus to the United States, then we should be willing for all other jurisdictions to do the same. The end result would be absurdity, with everyone trying to regulate everyone else. And the duplicative and overlapping regulations would inevitably lead to fragmentation in the global swaps markets—itself a potential source of systemic risk.[11] Instead, we should adopt a framework that applies CFTC regulations outside the United States only when it addresses one or more important risks to our markets.

Furthermore, we should afford comity to other regulators who have adopted comparable regulations, just as we expect them to do for us. This is especially important when we evaluate whether foreign subsidiaries of U.S. parent companies could pose a significant risk to our financial system. The categorical imperative leads us to an unavoidable result: We should not impose our regulations on the non-U.S. activities of non-U.S. companies in those jurisdictions that have comparable capital and margin requirements to our own.[12] By the same token, when U.S. subsidiaries of foreign companies operate within our borders, we expect them to follow our laws and regulations and not simply comply with rules from their home country.

Charity, it is often said, begins at home. The categorical imperative further compels us to avoid duplicating the work of other American regulators. If a foreign subsidiary of a U.S. financial institution is subject to consolidated regulation and supervision by the Federal Reserve Board, then we should defer to our domestic counterparts on questions of dealing activity outside the United States. The Federal Reserve Board has extensive regulatory and supervisory tools to ensure a holding company is prudent in its risk-taking at home and abroad.[13] The CFTC instead should focus on regulating dealing activity within the United States or with U.S. persons.

3. Pursue SEC Harmonization Where Appropriate

As I said in connection with our proposal of this rule, I find it surreal that the SEC and the CFTC, two federal agencies that regulate similar products pursuant to the same title of the same statute—with an explicit mandate to “consult and coordinate” with each other—have not agreed until today on how to define “U.S. person.” This failure to coordinate has unnecessarily increased operational and compliance costs for market participants.[14] I am pleased that this final rule uses the same definition of “U.S. person” as the SEC’s cross-border rulemaking.

To be sure, as my colleagues have said on several occasions, we should not harmonize with the SEC merely for the sake of harmonization.[15] We should do so only if it is sensible. In the first instance, we must determine whether Congress has explicitly asked us to do something different or implicitly did so by giving us a different statutory mandate. We must also consider whether differences in our respective products or markets warrant a divergent approach. Just as today’s final rule takes steps toward harmonization, it also diverges where appropriate.

The approach we have taken with respect to “ANE Transactions” is deliberately different than the SEC’s.[16] ANE Transactions are swap (or security-based swap) transactions between two non-U.S. persons that are “arranged, negotiated, or executed” by their personnel or agents located in the United States, but booked to entities outside America. While some or all of the front-end sales activity takes place in the United States, the financial risk of the transactions resides overseas.

Here, key differences in the markets for swaps and security-based swaps are dispositive. The swaps market is far more global than the security-based swaps market. While commodities such as gold and oil are traded throughout the world, equity and debt securities trade predominantly in the jurisdictions where they were issued. For this reason, security-based swaps are inextricably tied to the underlying security, and vice versa. This is particularly the case with single-name credit default swaps, where the arranging, negotiating, or execution is typically done in the United States because the underlying reference entity is a U.S. company. More generally, security-based swaps can affect the price and liquidity of the underlying security, so the SEC has a legitimate interest in regulating transactions in those instruments. By contrast, because commodities are traded globally, there is less need for the CFTC to apply its swaps rules to ANE Transactions.[17]

Moreover, as noted above, Congress directed the CFTC to regulate foreign swaps activities outside the United States that have a “direct and significant” connection to our financial system. Congress did not give a similar mandate to the SEC. As a result, the SEC has not crafted its cross-border rule to extend to an SRS engaged in security-based swap dealing activity offshore that may pose a systemic risk to our financial system. Our rule does with respect to swaps, aiming to protect American taxpayers from another Enron conducting its swaps activities through a major foreign subsidiary without CFTC oversight.

The final rule addresses Transaction-Level Requirements applicable to swap entities (specifically, the Group B and Group C requirements), but does not cover other Transaction-Level Requirements, such as the reporting, clearing, and trade execution requirements. The Commission intends to address these remaining Transaction-Level Requirements (the “Unaddressed TLRs”) in connection with future cross-border rulemakings. Until such time, the Commission will not consider, as a matter of policy, a non-U.S. swap entity’s use of their personnel or agents located in the United States to “arrange, negotiate, or execute” swap transactions with non-U.S. counterparties for purposes of determining whether Unaddressed TLRs apply to such transactions.

In connection with the final rule, DSIO has withdrawn Staff Advisory No. 13-69,[18] and, together with the Division of Clearing and Risk and the Division of Market Oversight, granted certain non-U.S. swap dealers no-action relief with respect to the applicability of the Unaddressed TLRs to their transactions with non-U.S. counterparties that are arranged, negotiated, or executed in the United States. In Staff Advisory 13-69, the CFTC’s staff applied Transaction-Level Requirements to ANE Transactions, without the Commission engaging in notice and comment rulemaking to determine whether such an application is appropriate. Going forward, I fully expect that the Commission will first conduct fact-finding to determine the extent to which ANE Transactions raise policy concerns that are not otherwise addressed by the CEA or our regulations.

Refinements to the Proposed Rule

In response to public comment, and consistent with the guiding principles described above, the final rule includes a number of refinements from the proposal issued last December. I will leave it to our extremely knowledgeable staff to outline all the changes in detail, but I will highlight some of the key refinements here. These principally concern the treatment of SRSs and U.S. branches of foreign swap entities.

1. Significant Risk Subsidiaries

As noted, the SRS concept is not intended to reach subsidiaries of holding companies that are subject to consolidated supervision by the Federal Reserve Board. The final rule recognizes that intermediate holding companies of foreign banking organizations under the Federal Reserve Board’s Regulation YY are subject to such consolidated supervision, and to enhanced capital, liquidity, risk-management, and stress-testing requirements. Accordingly, foreign subsidiaries of intermediate holding companies are excluded from the SRS definition under the final rule.

In addition, the final rule recognizes that certain SRSs may act as “customers” or “end users” in the global swaps markets, engaging in only a de minimis level of swap dealing or no dealing activity at all. Consistent with the principle of focusing on risk to the United States, the “Group B” category of risk-mitigating regulatory requirements will not apply to swaps between a non-U.S. swap entity and an SRS that is simply an end user.[19] This approach will help preserve end users’ access to liquidity in foreign markets.

For similar reasons, the final rule also provides a limited exception from the Group B requirements for a swap entity that is an SRS or a guaranteed entity—to the extent that swap entity’s counterparty is an SRS end user or an Other Non-U.S. Person that is not a swap entity. In addition, the final rule clarifies that a non-U.S. person that is not itself an SRS or a guaranteed entity need not count swaps with an SRS toward its swap dealer de minimis threshold, unless that SRS is a guaranteed entity.

I believe these adjustments to the proposed SRS regime will further serve to channel our regulatory resources, while offering appropriate deference to our domestic and foreign regulatory counterparts.

2. U.S. Branches

The final rule also includes two key changes to the treatment of U.S. branches of foreign swap entities. First, it expands the availability of substituted compliance for the Group B requirements to include swaps between such a U.S. branch, on the one hand, and an SRS or Other Non-U.S. Person, on the other.[20] And second, it creates a new exception from the “Group C” external business conduct standards for swaps between U.S. branches and foreign counterparties (other than guaranteed entities and foreign branches of U.S. swap entities). These changes recognize that U.S. branches, though located on U.S. soil, are part of a non-U.S. legal entity. Accordingly, while such branches should be subject to certain risk-mitigating regulations, they should not be subject to the full panoply of requirements applicable to true U.S. persons.  

Conclusion

In sum, the final rule before us today provides a critical measure of regulatory certainty for the global swaps markets. I believe the rule is also a sensible and principled approach to addressing when foreign transactions should fall within the CFTC’s swap entity registration and related requirements.

I have noted before President Eisenhower’s observation that “The world must learn to work together, or finally it will not work at all.” I sincerely hope our domestic and international counterparts will view today’s action as a positive step toward further cooperation to provide sound regulation to the global swaps markets.