As financial market regulators seek to coordinate their post-financial crisis reforms, a contentious question is to what extent one nation's regulations apply to companies in other countries. The general principle under the Dodd-Frank Act is that U.S. derivatives (swaps) regulation only applies to transactions that have a significant connection or effect on the U.S.
Much of the debate surrounding the Commodity Futures Trading Commission's (CFTC) regulation of cross-border swaps transactions has centered around which firms are subject to U.S. regulation either because they fall under the definition of a "U.S. person" or because they engage in transactions with U.S. firms. The key worries underlying these debates are subjecting foreign firms to onerous and duplicative U.S. regulation, and whether doing so will undermine the ability of U.S. firms to do business internationally.
But there's a good possibility that the content of U.S. regulation and concerns about who is ensnared by U.S. regulation will eventually become irrelevant to overseas firms.
This is because CFTC regulations do not apply to foreign firms if the CFTC determines that the foreign country's regulations are comparable to its own. On December 20, 2013, the CFTC determined that the swaps regulations of six non-U.S. jurisdictions (Australia, Canada, the European Union, Hong Kong, Japan, and Switzerland) were comparable. This means that firms in those six jurisdictions that would otherwise be subject to U.S. law because of their trades with U.S. firms are now exempt.
The only thing preventing non-U.S. firms in those six jurisdictions from never having to worry about compliance with U.S. regulation is that the CFTC limited its comparability assessments to only a portion of its derivatives regime. As the law firm Sullivan and Cromwell observed, "[i]t is notable that the CFTC has not made any comparability determinations with respect to the CFTC’s mandatory clearing...trade-execution requirements...[and] margining for uncleared swaps."
The reason that the CFTC's failure to make comparability determinations in those areas is notable is because doing so would likely result in the vast majority of non-U.S. firms not being required to comply with the core requirements of U.S. derivatives regulation; namely, mandatory clearing and trade-execution for all swaps transactions, and lots of collateral for any exempted (uncleared) swaps.
The possibility that the CFTC will ultimately make comparability assessments in the areas it has not done so is a good one. Right now, the CFTC's approach is piecemeal and fails to comport with the approach widely agreed upon by international financial regulators, including the Securities and Exchange Commission.
Over time, market participants will likely convince regulators to remove duplicative regulations among otherwise equivalent regulatory regimes. When that happens, the more important issue will be what derivatives regimes are considered comparable to those that are already recognized as a comparable to one another, and not the specific rules of any regime or the risk of being subject to a foreign jurisdiction's regulations.