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Tuesday, 23 December 2014

CFTC rules divide Asia

US swaps regulation does not treat all of Asia Pacific equally

TOP STORY: Derivatives

CFTC rules divide Asia

New guidance on US derivatives regulation could compel swaps dealers to channel business away from jurisdictions like Singapore, South Korea or Taiwan and into Hong Kong, Japan and Australia.

The US Commodity Futures Trading Commission on July 12 adopted final cross-border guidance related to swaps contracts between US and non-US entities, but granted temporary extensions to dealers on a list of preferred jurisdictions.

Banks in Hong Kong, Japan and Australia – the only favoured countries in Asia Pacific – have an extension until December 21, while dealers in the rest of the region must comply with the rules within 75 days of the guidance being published in the Federal Register, the official government journal. Otherwise, they cannot do businesses with US entities. That guidance was yet to be published as IFR Asia went to press.

Among the more complicated issues surrounding the CFTC’s regulations has been – and still is – just how Asian dealmakers will continue to write contracts with US firms in the multi-trillion dollar derivatives market.

Banks in Asia Pacific have, predictably, given the wide-reaching US rules short shrift. Before the now postponed original July 13 deadline for full compliance, many derivatives dealers in the region had chosen to ignore US disclosure guidelines altogether. Indeed, one of the reasons that the CFTC included Hong Kong, Japan and Australia among its list of preferred jurisdictions is that dealers in those markets had been the most willing to comply.

In the new guidance, the CFTC said it would allow US institutions and their counterparties in those three markets – along with the European Union, Switzerland and Canada – to operate more or less under local rules until December 21. The CFTC is expected to allow for substituted compliance in those jurisdictions, meaning local rules would, in many cases, prevail beyond that extended deadline.

Reporting requirements

Should the latest version of cross-border regulation remain unchanged, it could channel more US derivatives business into Asia’s three approved jurisdictions, where the reporting requirements and other costly paperwork would be much less onerous than elsewhere in the region.

The rest of Asia Pacific would be effectively limited to swaps business with non-US entities. That may have an impact on Singapore, Taiwan and South Korea, three of the Asia’s most active derivatives markets.

“If I were the MAS, Singapore’s regulator, I would be writing to the CFTC right now for the same treatment as Hong Kong, Australia and Japan,” said Scott Cammarn, partner, at Cadwalader, Wickersham & Taft in New York. “The same thing for regulators in Taipei and Seoul – all of these locales are at a disadvantage [in transacting with US persons].”

Outside of the three approved Asia Pacific markets, banks will have to register the details of US-related transactions with the CFTC – a requirement that may conflict with local data privacy laws. Any bank that records more than US$8bn of swaps with US entities in a 12-month period is required to register as a swap dealer, subject to more arduous reporting requirements under the Dodd-Frank Act. This was a substantial incentive to direct business to one of the three approved markets when US entities were involved, sources said.

“A US bank with branches in Hong Kong and Singapore doing business with a Singapore company will want to push swaps businesses to its Hong Kong branch because of the new regulation,” said Steven Lofchie, also a partner at Cadwalader. “It’s one of the unintended consequences.”

Unintended consequences

Perhaps, the most unexpected consequence is the effect the new regulation could have on US institutions that want to participate in Asia’s derivatives market.

“The concern we have is that if you’re a swap dealer or major swap participant located in Hong Kong [and] Japan, you get relief, but, if you’re a branch of a US swap dealer elsewhere in Asia, it would appear you’re not eligible for that relief,” said Mark Austen, CEO of Asia Securities Industry & Financial Markets Association.

“It is unclear what will happen when a bank applies for substituted compliance in one of those jurisdictions. That uncertainty is not good for the continued development of the Asian market,” Austen added.

Meanwhile, the different treatment of US and Asian institutions could create a market opportunity for Asian swaps dealers, sources said. If the regulation stays unchanged, a larger part of the global derivatives market could drift away from US firms.

“The institutions in the part of the world not exempted are going to do everything they need to do not to do business with US entities,” Lofchie said. “How is a firm in Malaysia, for instance, going to comply with all those CFTC rules?”

Avoiding US-related business could have the effect of dislocating hundreds of billions of dollars of US derivatives contracts inside and outside Asia. Asian banks may have to choose to do US-related swaps business only in approved markets in the region, but it is US banks that might find their markets most hemmed in.

“I don’t know if it will negatively affect Asia as a whole, besides advantaging favoured countries over disfavoured,” Lofchie said. “Now, non-US entities will not want to do business with US entities if it will subject them to additional requirements or requirement to register. They are going to have to pick their counterparties carefully so as to avoid US regulation.”

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