Substituted compliance, whereby local regulations are substituted with similar, foreign regulations due to their relative comparability to the CFTC’s rules on cross border swap trading, exists in a variety of forms across several jurisdictions, though there is little evidence of directly comparable regulations between many territories.
According to a report by GreySpark Partners, regulatory interoperability across jurisdictions, pursuing a variety of regulatory agendas, is a myth. There is a great and costly challenge to integrate many complex legal and regulatory infrastructures. Without a single, truly global regulatory body with the authority to sanction deviants there is no likelihood of seamless information exchange or the need for overseas counterparties to conform to absolutely standardized compliance requirements, according to the report.
“There is strong evidence of a trend toward increased international cooperation in terms of regulatory reciprocity, particularly where information exchange allows for mutually beneficial endorsement of regulations that are cross-border in nature,” said Saoirse Kennedy, GreySpark analyst consultant and lead author of the report.
The report – titled The Global Regulatory Landscape 2013: Five Key Regulatory Initiatives Impacting Global Wholesale Finance – provides an analysis of financial transactions tax (FTT), the U.S. Foreign Account Tax Compliance Act (Fatca), the EU’s Markets in Financial Instruments Directive (MiFID II) and European Market Infrastructure Regulation (Emir), the U.S. Dodd-Frank Act (DFA) and the Basel III accords.
Exemptions to regulations offer compliance relief to entities and transactions under certain conditions. For example, in both the EU and the U.S., regulators appear to agree on the exemption of legitimate hedgers and certain end-users from bilateral clearing mandates.
However, they differ in the detail. Under the DFA, exemptions are in place for non-financial entities that use derivatives to hedge commercial risk while, for Emir, end-users are only exempt provided that their positions are legitimate hedges and fall below a certain threshold. The extent of exemptions across the regulations explored is not far-reaching enough to have a powerful market impact.
Asset managers and their clients that operate both inside and outside the United States may be subject to swap regulatory requirements under the Commission’s regulations and the regulations of the other jurisdictions in which they operate.
For example, a collective investment vehicle that is organized in the European Union and is not a U.S. person, when transacting with a U.S. swap dealer, may be subject to requirements such as swap reporting, clearing, trade execution, and portfolio reconciliation under both Emir and Commission regulations. However, substituted compliance would not be available to the collective investment vehicle because it is domiciled outside the United States.
“Where the Commission has determined that a foreign jurisdiction’s requirement is comparable to that of the Commission, both counterparties should be allowed to comply with the applicable comparable requirements,” said Matthew Nevins, associate general counsel of the Asset Management Group of the Securities Industry and Financial Markets Association (Sifma), in a comment letter. “This would avoid the counterparties being subject to potentially conflicting or duplicative regulatory requirements.”
As for Fatca and FTT, Bradley Wood, GreySpark partner, noted: “We expect to see a trend where institutions will be expected to share transaction information for the purposes of taxation with a wider breadth of jurisdictions, and consequently standardized reporting will become more likely. This will require investment to ensure cohesion in often uncoordinated business and technology streams.”