The top derivatives regulator urged closing a legal loophole for offshore hedge funds, warning it threatened to undo a deep overhaul of Wall Street after the credit meltdown.
The Commodity Futures Trading Commission requires hedge funds to send their trades of complex financial instruments through clearinghouses, traffic control centers that stand between buyers and sellers.
But because of the way another rule is worded, offshore hedge funds, such as those based in the Cayman Islands, can avoid the requirement, at least temporarily.
"If we don't address this, the P.O. boxes may be offshore in places like the Cayman Islands, but the risk will flow back here," CFTC Chairman Gary Gensler said in a speech.
The loophole was created in December, when the CFTC issued a so-called exemptive order to give foreign companies broad relief from its rules, because it had not decided how those rules apply to companies abroad.
The rule also exempted hedge funds registered in off-shore jurisdictions with not a single employee on the ground, but with their fund managers in the United States.
To fix the loophole, the CFTC needs to test not only where a company is headquartered, but also where its principal place of business is located, Gensler said.
The exemptive order expires on July 12, but it is not clear whether the CFTC will by then have finalized its cross-border rules, which depends on finding consensus or at least a majority among its five commissioners.
Such loopholes pose a real risk that the global clampdown on opaque practices in finance will not have the intended effect, Gensler said.
"It's easy for financial institutions to avoid reforms by setting up shop in an offshore locale, even if it's not much more than a tropical island P.O. box," he said.
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