JP Morgan is reorganising its derivatives trading entities to allow it to hold on to fleeing non-US clients in the midst of an international regulatory standoff over the impending reach of the US’s Dodd-Frank Act. The change is said to be a precursor to other US banks looking to regionalise their booking structure in response to US swaps rules.
The bank plans to designate three entities for derivatives trading with any client that is or could be deemed a “US person”, while the rest of its derivatives trading desks would be cordoned off into offshore entities that would deal exclusively with non-US persons.
“From their standpoint it may make sense, since it looks like there will be fragmentation between the US and other jurisdictions at least at the start, if not for a longer period of time,” said David Felsenthal, a partner at Clifford Chance in New York.
The regionalised booking structure would allow the bank to preserve relationships with non-US clients who have begun to shun US banks for swaps transactions for fear of being roped into Dodd-Frank requirements for execution, clearing, and reporting of swaps. But final rules on Dodd-Frank’s international reach are still very much up in the air and could conceivably come down on the wrong side of JP Morgan’s strategy.
“It’s always less efficient to break up your booking entities, so they’d better be pretty sure this is the way to go,” said the general counsel at a non-US swap dealer.
Currently, a non-US end-user transacting with a non-US counterparty is exempt from the expensive Dodd-Frank requirements. But the chief US swaps regulator, the Commodity Futures Trading Commission, is still locked in a debate with international regulators about how to define the term “US person” and when to allow non-US entities to substitute their home countries’ regimes for that of the US.
The agency is scheduled to release final guidance on those issues on July 12, at which point the success of such a restructuring should become clearer. “Based on the CFTC’s proposed guidance from last year, firms should prepare themselves for a broader definition of US person come July,” said Jeffrey Steiner, counsel at Gibson Dunn in Washington.
Lawyers said most US banks were either considering restructuring or were already undergoing the process. Some firms, the lawyers said, were focusing on setting up desks in Singapore, where regulations may end up being less stringent.
Derivatives trading in Singapore has gone through the roof during the past year. The volume of cleared derivatives through Singapore Exchange’s AsiaClear service rose by 11% to a new high of 80.2m contracts for 2012. In December, volume was up 55% from a year earlier at 8m contracts. Volume in OTC interest rate swaps, a service launched at the end of 2010 by the bourse, now totals S$316bn (US$255bn) notional, a 39% year-on-year gain for 2012.
“There are arguments the US is becoming less competitive,” said Elan Mendel, an attorney at Shipkevich PLLC. “In this global marketplace, when you have a jurisdiction where less work needs to be done to transact, the business is going to flock there. A lot of OTC transactions are no longer attractive to US investors because of all the hoops you have to jump through.”
Fragmentation and an exodus from the US swaps market have been US banks’ and corporations’ biggest fears since Dodd-Frank’s inception. But the ultimate question for JP Morgan and other US banks clawing at the market share they believe to be slipping away is whether their actions will constitute evasion of CFTC rules.
“It is difficult to say how the CFTC will eventually interpret their current anti-evasion rules since the language is relatively broad, but that ambiguity is part of what makes the statute so chilling,” said Kenneth Raisler, former general counsel at the CFTC and current partner at Sullivan & Cromwell.
JP Morgan declined to comment.