Tags: SEC | law | regulations | swaps

SEC Proposes Crossborder Swap Rules

By    |   Monday, 06 May 2013 01:50 PM

For some reason, or just by coincidence, the Securities and Exchange Commission (SEC) likes to issue major rules on May Days. The most famous of these will always be the rule abolishing fixed commissions on May Day of 1975, a rule I would say the securities industry is still trying to digest.

This May Day, in a meeting hastily convened without the usual one-week notice, the SEC delivered itself of its version of rules governing the regulation, mandated by the Dodd-Frank Act, of security-based swaps in global markets, which Chairman Mary Jo White and other commissioners hastened to point out is where most of this activity takes place.

It is essential to note that the SEC regulates only swaps tied to securities, whereas the bulk of swaps are based on commodity prices and are supposed to be regulated by the Commodity Futures Trading Commission (CFTC), an agency that has been drifting for many months under Chairman Gary Gensler, whose term expired a year ago and who is unable to muster a majority to convene the commission to finish the regulatory agenda of Dodd-Frank's Title VII nearly three years after the Act was signed into law. Gensler is fond of saying, "We're human, and we're going to do these regulations thoughtfully, and not against a clock."

Previous articles in this series have reported expressions of consternation by the securities industry and by foreign regulators over the determination by Gensler to assert the CFTC's authority over any transactions, even those conducted abroad, that entail risks that are likely "to wash back on our shores." Gensler has told Congress that when he worked at Goldman Sachs, he learned how to structure transactions to move risks to remote corners of the swaps space, and the events of 2008 showed that transactions and entities that have moved abroad in order to escape U.S. regulation can end up being guaranteed and bailed out by the U.S. government.

The industry has made it a top priority, if not the highest priority, to defeat these regulations, and legislators have stated at hearings that they have heard a strong message that the regulations could cause activity to migrate abroad and liquidity needed for hedging to be reduced, along with commissions for the swaps dealers.

The meeting looked like an episode of "Wag the Dog" in which the agency with the lesser stake in derivatives regulation sought to vitiate the policy Gensler is seeking to advance. Another way to look at it is that the SEC took the opportunity to fill the power vacuum created by the fact that the CFTC is even more dysfunctional than the SEC. Yet another perspective is that the proposal seemed to incorporate the language submitted by law firms representing the opponents of implementation of Title VII and that it constitutes a gift to the firms, which will have the opportunity to manage the process and encourage the SEC to do what it does best — to obtain exemptions, waivers and no-action letters for the clients of securities law firms.

Last week's action does two things. The first item is a lengthy proposal to enable entities involved in the security-based swaps business to apply for "substituted compliance" status, which would recognize that the compliance regimes of foreign jurisdictions are comparable to that of the United States, so that it will not be necessary to comply with both.

The second action is to reopen all of the regulations proposed by the SEC under Dodd-Frank, so that the public can comment on the effects of the regulations as a whole. All of this provides nice business for securities law firms.

The proposals were approved unanimously, but this does not necessarily mean they will get a smooth ride to adoption. Of the five commissioners, only White and her senior partner, Elisse Walter, gave unqualified support. Of the other three commissioners, while they supported putting the regulations out for comment, they reserved judgment on how they would vote on adoption.

Commissioner Luis Aguilar, the former lobbyist for the mutual fund industry who has blocked action to strengthen regulation of money market mutual funds, expressed concern that the regulations could create inconsistencies of treatment and loopholes that would bring overseas risks back to this country. His remarks read like they were prepared by supporters of Gensler's view. With a flourish, Aguilar placed the binder containing the documents on the dais and pointed out that it contains 1,000 two-sided pages and includes over 600 questions for comment.

The other two commissioners, Troy Paredes and Daniel Gallagher, are reserving judgment as to whether the proposal goes far enough in assuaging the concerns of the clients.

Two points that did not come up during the discussion lurk in the background. One is that the SEC's own record as a regulator is demonstrably poor, and its failure to implement the so-called "consolidated supervised entity" regime that was supposed to contain the risk posed by highly leveraged securities firms failed completely and contributed to the 2008 episode of the ongoing financial crisis, making Goldman Sachs and Morgan Stanley available for open-ended bailouts by the Treasury and Federal Reserve.

The other is the potential for these regulations to create a mom and pop enterprise that offers clients an opportunity to obtain the relief they seek if they patronize law firm A, firm B, firm C and especially firm D, to make sure that their cases are presented in a manner that will be well-received by the lawyers on the SEC staff.

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This May Day, in a meeting hastily convened without the usual one-week notice, the SEC delivered itself of its version of rules governing the regulation, mandated by the Dodd-Frank Act, of security-based swaps in global markets.
Monday, 06 May 2013 01:50 PM
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