Parallel U.S. and EU delays in derivatives market regulation

Parallel U.S. and EU delays in derivatives market regulation

Jacob Lew, U.S. Secretary of Treasury and chairman of the Financial Stability Oversight Council (FSOC).

Used under creative commons license from United States Government Work

A recent announcement by the European Commission has consequences for anyone affected by an interest rate, the price of oil or the price of wheat [read: everyone]. 

On June 15, Reuters reported that the European Commission had decided to extend the deadline for U.S. financial firms to comply with European Securities Market Authority (ESMA) regulatory deadlines. However, the compliance concession is deceptive since ESMA has yet to finish issuing rules that would apply to EU and non-EU financial firms. Rules to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act require that most trades be “cleared” on a central platform, to protect other market participants from the consequences of default by one or more counterparties to a trade.

Indeed, the U.S. and EU are among the Group of 20 members that committed to centralize clearing in 2009. ESMA is still trying to decide which commodity and financial contracts will have to be cleared. Other European market reform legislation has yet to be passed, much less implemented. In addition to extending its own deadline, the European Commission is hoping to use the “concession” as a bargaining chip to push the Commodity Futures Trading Commission (CFTC) into extending its July 12 compliance deadline for European financial firms on rules it has finalized. This proposed exchange for a European deadline extension to comply with rules it has yet to finalize, is disingenuous. Perfect synchronicity and harmonization in transatlantic rulemaking is not achievable. The CFTC should not, yet again, extend its compliance deadline beyond July 12 in response to the Commission’s gambit.

The EU deadline extension, from June 15 to September 1, is an advance guard of a broader diplomatic offensive on the eve of Commissioner Michel Barnier’s lobbying visit to U.S. financial and commodity regulatory agencies. An earlier salvo, an April 18 letter from Commissioner Barnier and eight Group of 20 ministers of finance to their counterpart U.S. Secretary of Treasury Jacob Lew, sought to enlist Lew to postpone the CFTC’s proposed guidance for cross-border implementation of Dodd-Frank.

Secretary Lew has given no indication about whether he would defend the cross-border guidance proposed by the CFTC, an agency with authority over about 85 percent of the $300 trillion U.S. derivatives market. While Secretary Lew does not have statutory authority over the derivatives market, as the Chairman of the Financial Stability Oversight Council (FSOC) he yields considerable power to prevent trading practices and transactions that would destabilize the U.S. economy. A new wave of poorly regulated derivatives trades run through High Frequency Trading (HFT) algorithms, for example, could lead to FSOC intervention under the leadership of a chairman willing to regulate his former Wall Street employers and colleagues. While U.S. agencies have no statutory authority to regulate High Frequency Trading, draft European legislation does provide for the beginning of HFT regulation. Secretary Lew could use his FSOC authority to propose that the U.S. Congress provide legislative authority for HFT regulation via the CFTC.

Unregulated HFT poses huge challenges to data surveillance. Lack of data surveillance, or indeed any regulation of over-the-counter (OTC) trades by the foreign affiliates of U.S. banks, was a main cause of the bank crisis that is estimated to have cost the U.S economy $13 trillion, along with bringing about untold human suffering.

The G-20 financial ministers’ June 7 press release gave no hint about when the leaders, including President Obama, would comply with their end-of-2012 commitment to clear the dark market OTC trades that devastated the world economy in 2007–2009. The exemptions, exclusions and waivers that the publicly rescued banks have sought threaten to continue the reign of dark markets over global finance. Furthermore, the bank lobbyists are awaiting the departure of three CFTC commissioners, including Chairman Gary Gensler, whom President Obama has declined to re-nominate, rather than face a protracted and possibly losing Senate confirmation vote. Absent a change in the political dynamic that is putting Wall Street, foreign banks, regulators and their Congressional allies in charge of dismantling Dodd-Frank, it seems likely, as noted in a recent Bank for International Settlements article, that publicly recapitalized banks will continue to trade high-risk products that have potential for systemic destabilization.