Today, the Securities and Exchange Commission (SEC) announced that it will be proposing new rules relating to how U.S. regulation under Title VII of the Dodd-Frank Act will apply to cross-border derivatives transactions.
In so doing, a significant difference seems to have emerged between how the SEC and the the Commodity Futures Trading Commission (CFTC) will go about regulating cross-border derivatives.
A major component of the SEC's and CFTC's rules is to allow certain foreign firms that trade swaps in the U.S. to be exempt from the agencies' respective regulations. The basic reason being that foreign firms may already be subject to comparable regulation in their home country such that compliance with U.S. rules would be unnecessary to protect U.S. participants or markets.
In other words, the SEC and CFTC will permit foreign firms to substitute compliance with their home country's regulation for their own.
Importantly, the SEC's analysis of foreign regulation will focus on "regulatory outcomes" as opposed actual rules and requirements. As the press release describing the SEC's proposed cross-border rules explains:
Under substituted compliance, a foreign market participant would be permitted to comply with the requirements imposed by its own home country, so long as those requirements achieve regulatory outcomes comparable with the regulatory outcomes of the relevant provisions of Title VII....the Commission would take a holistic approach... rather than basing the ultimate determination on a rule-by-rule comparison.
The SEC should be applauded for focusing on comparable regulatory outcomes instead of comparable rules and requirements. It means the SEC understands that there is more than one way to protect investors and markets. An outcome-based approach will permit foreign jurisdictions to experiment with different approaches to regulation without necessarily undermining their domestic participants' access to U.S. markets. Focusing on outcomes will also help prevent foreign firms from being subject to duplicative regulation and keep U.S. capital markets competitive.
Indeed, in a 2009 article published in the NYU Journal of International Law and Politics, Jerry Ellig and I called for an outcome-based approach towards substituted compliance with securities regulation. Using very similar language, we argued that
the SEC should permit substituted compliance with a foreign regulatory regime so long as that regime achieves investor-protection outcomes similar to the investor protection outcomes achieved by the SEC....Compliance with a regime having comparable regulatory outcomes would thereby serve as a substitute for standard registration and oversight by the SEC.
Notably, however, the SEC's outcome-based approach towards substituted compliance seems very different than the approach taken by the CFTC, which focuses more on rules and requirements in making a foreign regime comparability assessment. Instead of focusing on regulatory outcomes, the CFTC will focus on the following aspects of a foreign regime in determining whether the regime is comparable:
the scope and objectives of the regulatory requirement(s), the comprehensiveness of such requirements, the comprehensiveness of the foreign regulator’s supervisory compliance program; and the foreign regulator’s authority to support and enforce its oversight of the non-U.S. swap dealer or non-U.S. major swap participant.
There thus seems to be a fundamental difference in how the SEC and CFTC will go about determining whether a foreign regulatory regime is comparable to their own. Although differences between the two approaches may matter little in practice, the differences could ultimately impact which foreign jurisdictions are considered comparable to the U.S. and lead to regulatory arbitrage.