European Attacks on U.S. Regulators Must Not Be Allowed to Weaken U.S. Derivatives Rules

This is little more than a brazen attempt to bully U.S. regulators into delaying and weakening U.S. rules, which, as Senator Elizabeth Warren has pointed out, must not happen.
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Michel Barnier, the European Commissioner for internal markets and services, unleashed an unprecedented and highly improper attack on U.S. regulators generally and the Commodity Futures Trading Commission (CFTC) and its Chairman, Gary Gensler, in particular (notably without actually naming the CFTC or Mr. Gensler). Mr. Barnier, in a Bloomberg op-ed, criticized the CFTC approach to cross-border implementation of the Dodd Frank financial reform law and the implementing regulations relating to derivatives, what Warren Buffett correctly referred to as "financial weapons of mass destruction."

Mr. Barnier, however, has grossly overstated what the Europeans have done and distorted what is being done in the U.S. Making matters worse, the timing of Mr. Barnier's misleading public broadside against U.S. regulations is a clear attempt to interfere with ongoing, sensitive deliberations among U.S. regulators. Last December, the CFTC set a deadline of July 12 regarding its cross-border approach and, with just three weeks to go, Mr. Barnier published his attack in an inappropriate attempt to influence the CFTC and U.S. rulemaking.

The primary premise of Mr. Barnier's opinion piece is simply wrong: Europe's rules are not stronger and better than the U.S. rules and the U.S. should not surrender its regulatory duties to European rules or wait for Europe to finish the many rules still being negotiated. A truth Mr. Barnier failed to mention is that Europe is years behind the U.S. in passing financial reform laws and regulations generally and derivatives rules in particular.

For example, Mr. Barnier touts the European rules embodied in the European Markets and Infrastructure Regulation (EMIR). However, with respect to central clearing, the CFTC regime is stronger than that of Europe. In Europe, all financial counterparties must clear. Non-financial so-called end-users are exempted from clearing for any bona fide hedge transaction, and are also given an additional bonus "threshold" of €1bn to €3bn to take speculative derivatives positions in various classes of swaps. In the United States, all financial firms will also have to clear, and Swap Dealers, Major Swap Participants and active funds are already required to do so. Furthermore, non-financial end-users have to clear everything that is not a bona fide hedge (there are no speculative thresholds as there are in EMIR). Clearly, this is a more exacting standard than that of EMIR.

Furthermore, when it comes to the question of what must be cleared, the US is also ahead of Europe because the CFTC has already mandated that interest rate and credit index products must be cleared. While it is conceivable that Europe will eventually mandate more products for clearing than the CFTC, the fact is they have, to date, mandated none.

The same is true for the inaccurate claims made by Mr. Barnier that EMIR is better than the U.S. regarding pre-and post-trade transparency. Pre-trade transparency regulation in Europe is not even covered by EMIR, but by what is referred to as "MiFID2" and "MiFIR," both of which are in the middle of years-long negotiations, which will not be finalized for years more. Post-trade transparency, on the other hand, is covered by EMIR, but the U.S. rules are stronger: European rules call for just daily reporting, while the U.S. requires real-time reporting, which is better by any standard.

This raises a key omission by Mr. Barnier: MiFID2/MiFIR, which covers execution, position limits and other critical derivatives provisions. MiFID2/MiFIR will almost certainly not come into effect or be implemented until at least 2015, and perhaps not until 2017 according to recent estimates. Until MiFID2/MiFIR are negotiated, agreed-to, finalized, effective and implemented, Europe simply will not have comprehensive Dodd Frank Title VII-like derivatives regulation.

Also, contrary to Mr. Barnier's assertion, no U.S. regulator is in favor of "imposing U.S. rules worldwide." But, because the U.S. had to bailout international derivatives dealers during the last crisis, the Dodd-Frank financial reform law expressly requires the CFTC to enforce derivatives rules to cross border transactions, although limited to only those transactions that have a "direct and significant" impact on the U.S. Remember, of the 22 AIG counterparties bailed out by the U.S. government in 2008, 17 were foreign banks. Of the 20 largest users of Federal Reserve Bank's emergency lending facilities, nine were foreign banks. In addition, the Fed had to pump $1.9 trillion into foreign swap lines in the 30 days after the collapse of Lehman Brothers and $5.4 trillion in the 90 days after its collapse. Cross border derivatives transactions directly threaten the financial stability of the U.S. and must be regulated to protect U.S. taxpayers.

But, even where cross border derivatives activity does pose a direct threat to the U.S., proposed U.S. regulations nonetheless allow for foreign regulators to apply foreign regulations as long as they are genuinely comparable to U.S. rules (so called "substituted compliance"). This is a generous accommodation given how foreign regulators tragically failed to protect their own depositors, taxpayers and treasuries during the last crisis, as evidenced by the number of banks that were nationalized (many with liabilities exceeding the GDP of the entire country).

(Mr. Barnier is correct as to one derivatives regulation where Europe is stronger than the U.S.: foreign exchange swaps. However, this mistaken decision to exempt FX swaps from derivatives regulation, strenuously opposed by Better Markets, has nothing to do with the CFTC because it was solely a decision of the Treasury Department.)

Mr. Barnier's op-ed was ostensibly to promote "cooperation ... not confrontation" among regulators, but he nonetheless meritlessly pounded the CFTC and Chairman Gensler's approach as weak, "flawed" and "self-defeating." This is little more than a brazen attempt to bully U.S. regulators into delaying and weakening U.S. rules, which, as Senator Elizabeth Warren has pointed out, must not happen. Mr. Barnier should focus on the extensive amount of financial reform that Europeans need to pass and implement. If he and they did that, they might find a much more receptive audience in the U.S., especially if he uses facts rather than misleading and incomplete attacks on U.S. regulators and regulations.

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