Just one day in advance of the December 21, 2013 expiration of the CFTC’s exemptive order delaying the applicability of some CFTC swap regulations for non-U.S. swap dealers and foreign branches of U.S. swap dealers, the CFTC approved a series of comparability determinations. These comparability determinations will allow CFTC-registered non-U.S. swap dealers and foreign branches of U.S. swap dealers to comply with local requirements rather than the corresponding CFTC rules in cases where substituted compliance is available under the CFTC’s cross-border guidance.  The CFTC made comparability determinations for some swap dealer entity-level requirements for Australia, Canada, the European Union (the “EU”), Hong Kong, Japan and Switzerland and for a limited number of transaction-level requirements for the EU and Japan.
Archive for the ‘Derivatives’ Category
Bankruptcy law in the United States, which serves as an important precedent for the treatment of derivatives under insolvency law worldwide, gives creditors in derivatives transactions special rights and immunities in the bankruptcy process, including virtually unlimited enforcement rights against the debtor (hereinafter, the “safe harbor”). The concern is that these special rights and immunities grew incrementally, primarily due to industry lobbying and without a systematic and rigorous vetting of their consequences.
This type of legislative accretion process is a form of path dependence—a process in which the outcome is shaped by its historical path. To understand path dependence, consider Professor Mark Roe’s example of an 18th century fur trader who cuts a winding path through the woods to avoid dangers. Later travelers follow this path, and in time it becomes a paved road and houses and industry are erected alongside. Although the dangers that affected the fur trader are long gone, few question the road’s inefficiently winding route.
On November 5, 2013, the Commodity Futures Trading Commission proposed rules to establish new position limits that would apply to 28 agricultural, energy and metals futures contracts, and swaps, futures and options that are economically equivalent to those contracts.  Once adopted, the proposal would reinstate, with certain changes, the position limit rules that were vacated by a U.S. federal court in 2012 (the “Vacated Rules”).  The CFTC also re-proposed aggregation standards that are similar to those initially proposed as amendments to the Vacated Rules, but with a few notable differences, to be used in applying position limits (the “Aggregation Proposal”). 
The proposals would:
In my paper, Insider Trading in the Derivatives Markets, recently made available on SSRN, I argue that the prohibition against insider trading is becoming increasingly anachronistic in markets where derivatives like credit default swaps (CDS) trade. I demonstrate that the emergence of credit derivatives marks a profound development for the prohibition against insider trading, problematizing conventional theory and doctrine like never before. With the workability of current rules subject to question, this paper advocates for a rethinking of the present regulatory framework for one better suited to modern markets.
Lenders use CDS to trade the risk of the loans they make. And, when they engage in such trading, they are usually privy to vast reserves of confidential information on their borrowers. From a doctrinal perspective, CDS appear to subvert insider trading laws by their very design, insofar as lenders rely on what looks like insider information to transfer the risk of a loan to another institution. Fundamentally, insider trading rules prohibit trading based on information procured at an unfair advantage by those in a privileged relationship to a company. And, increasingly, insider trading laws are taking a fairly broad approach in preventing misuse of confidential information by those who acquire this information through their special access or through deception. For example, Rule 10b-5(2) can ground a claim for insider trading where someone trades on information obtained through a relationship of trust and confidence. In the CDS market, lenders usually buy and sell credit protection based, at least in part, on information they obtain in their relationship with the borrower, one ordinarily protected by restrictive confidentiality clauses. From the doctrinal viewpoint then, old laws and new CDS markets appear to exist in a state of serious tension. Put differently, either this thriving market is operating outside or at the margins of existing law—or the law itself has not adapted to the existence of these markets.
The Basel Committee on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions (“IOSCO”) on September 2 released their final policy framework on margin requirements for uncleared derivatives (the “Framework”). The Framework, which follows two proposals on the topic from BCBS and IOSCO (the “Proposals”), is intended to establish minimum standards for uncleared derivatives margin rules in the jurisdictions of BCBS and IOSCO’s members, which includes the United States.
The Framework is designed to provide guidance to national regulators in implementing G-20 commitments for uncleared derivatives margin requirements. In the United States, the Dodd-Frank Act, reflecting the same G-20 commitments, requires the SEC, CFTC and banking regulators to adopt initial and variation margin requirements for swap dealers and major swap participants (“MSPs”) under their supervision.  The U.S. regulators have proposed rules to implement these requirements (the “U.S. Proposals”), but have not yet adopted final rules, in part due to the ongoing BCBS/IOSCO efforts. The Framework is similar in concept to the U.S. Proposals, but differs in a number of significant respects. Appendix A summarizes the Framework and the three U.S. Proposals, highlighting a number of the key differences.
With the Framework finalized, we expect that U.S. regulators will work to issue final rules implementing uncleared swap margin requirements in the coming months.
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and new Commodity Futures Trading Commission (CFTC) rules require that, subject to certain exceptions, swap counterparties clear swaps at a clearing house and execute them on a facility or exchange. One of these exceptions is the “end-user exception,” which may be available for companies that are not “financial entities” and that use swaps to manage risk. There are several requirements that these entities must meet in order to rely on the end-user exception. For public companies, these include taking certain governance steps that involve board-level approval of the company’s use of uncleared swaps and review of company policies on swaps. With the CFTC clearing requirements applicable to non-financial entities scheduled to take effect September 9, public companies can position themselves to take advantage of the end-user exception by completing these steps in the next few months.
The working paper, Hardwired Conflicts: The Big Bang Protocol, Libor and the Paradox of Private Ordering, examines the darker side of the private market structures at the heart of the global financial system.
Imagine we allowed referees to place bets on the sporting events they officiated. On one level, this would almost certainly offend our sense of fair play. On another level, however, we might ultimately view this as unproblematic insofar as teams were able to freely contract with those referees willing to make credible commitments not to exploit such conflicts of interest, and so long as compliance with these contracts was relatively easy to monitor and enforce. Imagine now, however, that there exists a limited number of qualified referees, that these referees coordinate in the development of a standard form contract which does not prohibit betting on games, and that they collectively enjoy sufficient market power to ensure that these contracts receive widespread adoption. Imagine further that the costs of determining whether a referee had in fact wagered on a game are extremely high and, as a corollary, that there exists no credible threat of either private contractual enforcement or market-based (reputational) sanctions. Given these additional facts, we might be of the view that this state of affairs is likely to undermine confidence in the integrity of the game. Indeed, it is precisely for this reason that professional sports leagues prohibit referees from wagering on games. It seems remarkable, therefore, that we permit this type of activity in the most high stakes game of all: finance.
I’d like to describe the Commission’s recent set of proposals on the cross-border regulation of derivatives. First, though, I’ll describe the state of play among international regulators, both in developing their derivatives regimes and in grappling with the thorny cross-border aspects of derivatives trading.
Status of International Regulatory Efforts
Countries are at various stages of implementing their derivatives regimes in response to the G20 commitments.
The U.S. is further along in this effort. The SEC has now proposed substantially all of the rules required by Title VII, and we have adopted the foundational definitional rules and those governing swap clearing agencies standards, among others. The CFTC is further along in the adoption mode and is on track to complete the adoption of their rules later this year.
Other jurisdictions are further behind, which means that it is difficult to assess at this point how similar their requirements may be to those that the U.S. is implementing.
During the past four years, the Commodity Futures Trading Commission (“CFTC” or the “Commission”) has substantially expanded its regulatory reach and flexed stronger enforcement muscles. Since 2010, the CFTC has dramatically increased its annual enforcement action totals, and has imposed record high financial penalties on significant market participants. In 2011 and 2012, the CFTC filed at least 201 enforcement actions, almost as many as the past five years combined, and has already recovered approximately $1.8 billion in total sanctions. As CFTC Chairman Gary Gensler has stated, “Dodd-Frank expands the CFTC’s arsenal of enforcement tools. We will use these tools to be a more effective cop on the beat, to promote market integrity, and to protect market participants.” Notwithstanding budgetary constraints, the next four years are likely to show continued emphasis on expanded enforcement efforts as the agency implements its new rules. This post focuses on the CFTC’s new rulemakings and how Title VII has increased the CFTC’s power to create and police the derivatives markets.
I. Expanding the CFTC’s Enforcement Actions
Over the past two years, the agency has hit record levels of enforcement actions and civil penalties imposed. Figure 1 below details the types of enforcement actions that the CFTC has brought from 2006 through 2012, as well as the total amounts of monetary penalties it recovered during each fiscal year.
Today [May 1, 2013], the Commission considers issuing a release proposing rules and interpretive guidance applicable to certain market intermediaries, participants, clearing agencies, data repositories, and trade execution facilities that are involved in cross-border transactions of security-based swaps. The proposed release is over 1,000 pages, contains over 2,000 footnotes, and requests comments on more than 630 questions with many subparts. Although the questions posed are many, they are intended to be balanced and fair to solicit views from all sides. This is a welcome approach, because it contributes to a healthy debate and dialogue that is vital to the Commission’s processes.
Today, the Commission also votes to reopen the comment period on the various outstanding rulemaking releases and policy statement concerning security-based swaps and market participants to allow the public additional time to analyze and provide comments in light of our cross-border release.
The length of the cross-border release and the reopening of the comment periods reflect the complexity and importance of the issues involved in securities-based swap transactions. In issuing today’s proposal and asking for comments on the Commission’s proposed approach to regulating the securities-based swap market, the Commission recognizes the interactions among many important rules in this area. It is important, therefore, that our rules avoid gaps and loopholes, and that they work together to provide the needed transparency, accountability, and protection to our economy, the markets, and, most importantly, to investors.