The crush of new regulations has rekindled fears of regulatory arbitrage among market participants, who are worried about being whipsawed by competing rules and jurisdictional disputes.
“There is a concern growing globally that the U.S. regulations are a bit overstepping their jurisdictions, especially when dealing with non-U.S. institutions or individuals,” said Zohar Hod, head of sales at SuperDerivatives, a U.S. options pricing specialist.
The interconnectedness of the global economy is reflected in an increase in cross-border trading, which exacerbates the risk that parties to a transaction will be subject to multiple regulations.
For example, average monthly outflows of U.S. investments into Latin America have risen from $1 billion prior to the financial crisis to $4 billion currently, according to a report by research firm Celent.
The countries which have seen the highest U.S. investments post-crisis include Australia, Hong Kong and South Korea in Asia-Pacific; Brazil, Canada and Mexico in the Americas; and offshore financial centers such as Luxembourg, Switzerland and the Cayman Islands.
These countries have also experienced an increase in their investments in U.S. securities, the report said.
“Due to lack of consistency in global enforcements of regulations, what loopholes are going to be created, and what are the unintended consequences?” said Hod. “Do trades move to one financial center over the other? Who are the winners and losers?”
European regulators have asked the U.S. Commodity Futures Trading Commission to provide more clarity on the cross-border implications of the Dodd-Frank Act, which imposes new requirements to execute and clear most OTC derivatives.
The European Commission is of the view that the CFTC’s proposed interpretive guidance, issued in June, requires further review in order to avoid duplicative and conflicting requirements and rules.
The CFTC interpretive guidance describes how the agency will consider the application of clearing, trade execution and reporting and record keeping provision under Dodd-Frank to cross-border swaps involving counterparties that are not swap dealers or major swap participants.
“Many see the U.S. as imposing stricter rules that are not in line with other local jurisdictions, like Europe for example,” Hod said. “Regulatory arbitrage is going to be influencing the locations of where any type of OTC derivatives transaction will occur, and will naturally migrate to less regulated locations.
Coordinating and closing these loopholes are very difficult to do and will become even more difficult if there is an administration change in the U.S. in November following the presidential elections.
In the meantime, “non-U.S. regulators would want to have the best coordination on one hand, but also keep the self-regulation nature of their own political environment at the forefront”, Hod said.
The U.K. Financial Services Authority has expressed concern that the proposed cross-border guidance will require firms to meet Dodd-Frank transaction-level requirements where one of the counterparties is a U.S. person, which could result in the Dodd-Frank requirements being exported to a wide range of U.K. and other European Union firms.
Anglo-French clearer LCH.Clearnet has urged the CFTC to reach agreement with its foreign regulatory counterparts on the cross-border application of Dodd-Frank.
