What with Egypt’s coup and the asylum-seeking escapades of national-security leaker Edward Snowden, you may have missed the fratricide taking place at one of the U.S.’s most important financial regulatory agencies.
The Commodity Futures Trading Commission is in the final stages of deciding how broadly to apply new derivatives rules across borders. U.S. and European Union regulators have been at odds over the issue, but a deal is imminent, according to Bloomberg News. This is an underreported yet vital part of efforts to fix financial regulation.
Progress has been slow on all fronts. This week, for example, U.S. regulators proposed more demanding capital standards for big banks; if adopted, which isn’t certain, these would come into effect in 2018, 10 years after the financial meltdown began. The need for still more discussion and the dangers of further delay are main points of contention in the quarrel over derivatives.
CFTC Chairman Gary Gensler wants to impose new standards not just on overseas units of U.S. banks and foreign institutions operating in the U.S., but also on hedge funds in the Caribbean whose owners are American and on foreign banks if one side of a derivatives deal is guaranteed by a U.S. parent. Such expansive jurisdiction is a controversial idea in its own right. In addition, Gensler wants action now.
He’s opposed by two other CFTC commissioners, including a Democrat appointed by President Barack Obama. That’s not all: Six Democratic senators, numerous House and Senate Republicans, the aforementioned EU regulators and large banks are lined up against him. The Securities and Exchange Commission, which has authority over a smaller part of the derivatives business, has advocated a gentler line, and Treasury Secretary Jacob Lew has reportedly told Gensler to play more nicely with other regulators at home and abroad.
Facing such universal opposition, Gensler must surely be wrong -- or so you’d imagine. We think he has a point.
The derivatives business is global, and the transfer of risk (that’s what derivatives are designed to do) across borders isn’t confined to traders sitting in New York. History has shown repeatedly that problems originating overseas often come crashing back to the U.S.’s shores.
That was the broader lesson of 2008, when American International Group Inc.’s vast credit-default-swaps business almost sank the financial system. It operated out of a London branch that itself was a unit of a French-registered bank. The London trades were guaranteed by the U.S. parent, and ultimately by U.S. taxpayers. And lest we forget, JPMorgan Chase & Co.’s $6.2 billion in losses from bad bets on credit derivative indexes were booked from London.
The Dodd-Frank financial reform law instructs the CFTC to say how its rules will make sure there are no more AIGs. That means the rules must reach U.S. financial players no matter where they operate, and must cover foreign traders if they do business in the U.S.
Already, the CFTC has delayed final action for six months, after first proposing its cross-border guidelines a year ago. EU officials, in arguing for another postponement, say it would be wrong for the U.S. to act before Europe is ready. In principle, this is true. Precisely because the derivatives business is global, it demands a harmonized system of cross-border oversight. Gensler’s critics are right that intersecting jurisdictions and incompatible rules are no way to make finance safer.
But, Gensler can reasonably ask, how long does Europe need to figure things out? Five years after the 2008 meltdown, its regulators are calling for more time. Europe’s objections would command more respect if its regulators had shown more urgency.
U.S. banks operating in Europe, meanwhile, say they would be at a competitive disadvantage if they have to follow costly rules that their EU rivals don’t. Again, they’re right: A level financial playing field is another reason to prefer harmonization over unilateral action. But supporting the competitiveness of U.S. banks ought to be balanced with the need for financial safety.
So what can we hope for? Lacking the necessary third vote (the commission temporarily is down to four commissioners from the usual five) for the cross-border rules, and under pressure to mollify the EU, Gensler is likely to agree to a phase-in period and to allow the EU to substitute its own rules -- if they are substantially equivalent -- once they are final. For now, that would be an acceptable outcome, as long as the CFTC adopts the rest of its guidelines on July 12, as originally planned. It would maintain pressure on Europe to complete work on its rules while leaving the door open for further efforts to improve cross-border coherence.
Some of Gensler’s previous efforts to regulate derivatives struck us as overkill. Yet we applaud the chairman, who is expected to leave government as soon as a replacement is nominated and confirmed, for using his expertise as a former trader at Goldman Sachs Group Inc. to fight for a more transparent and less risky system.
Safer global finance requires adequately strict regulation and effective international cooperation. One out of two isn’t good enough. It has to be both.
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