UPDATE – US swaps regulator CFTC to close cross-border loophole

2 min read
Americas

(Reuters) - The US derivatives market regulator on Monday proposed a rule for safety margins for uncleared swaps to close a loophole Wall Street banks have used to duck new trading provisions by shifting business abroad.

(Rewrites throughout with details from conference call)

US firms would have to comply with the regulation, which the Commodity Futures Trading Commission adopted unanimously, in most cases, even when doing business abroad.

“The rule today is a proper response to the concern that off-shore swaps can result in risk flowing back into this country,” CFTC Chairman Tim Massad said.

The US$630trn global swaps market, which was largely unregulated before the 2007–09 financial crisis, is dominated by large US banks such as Bank of America, Citigroup and JP Morgan Chase.

The market was subjected to tough new rules after the crisis. But much of the CFTC’s new regime does not apply to foreign units of US firms as long as they do not have a financial guarantee from the parent company.

As a result, some firms removed the guarantees from the foreign units in order to escape the rules for swaps, a common type of derivative used to hedge risk.

“We did find that some institutions had modified their behaviour to either remove the parent guarantees or to stop giving parent guarantees,” Massad said.

Under the plan, first floated by Massad in a speech earlier this month, a bank would need to comply with the US rules if the foreign unit was consolidated into the financial statements of the US parent company.

The new rule, which will be finalized after a period during which the industry can comment, only applies to cash, or margin, that buyers and sellers need to set aside for swaps that aren’t guaranteed by clearing houses.

Reporting by Douwe Miedema; Additional reporting Sarah N. Lynch