CFTC Chairman Gary Gensler has often said that weak rules on regulatory jurisdiction across borders could blow a hole in the bottom of financial reform. He is right. In a recent speech on the subject, he said: “All of these common- sense reforms Congress mandated, however, could be undone if the overseas guaranteed affiliates and branches of U.S. persons are allowed to operate outside of these important requirements.”
Imagine what it would do to financial reform if banks could avoid regulation by transacting derivatives through offshore affiliates that they fully guarantee and whose profits and losses they absorb. What an absurd outcome!
A three-cornered fight over cross border jurisdiction has become so complicated and intense that the Chairman has but one rational option: allow the US rules to go into effect without any guidance on how jurisdictional conflict or overlap will be resolved. That will stifle the bickering in a New York minute.
Each of the big US banks operates through thousands of affiliates for the specific purpose of optimizing regulatory and tax effects on profitability. They pick the rules that maximize profits. Gensler should know about this. He had the job of managing the process at Goldman Sachs.
Derivatives trading transcends our concepts of sovereign jurisdiction. These contracts are, to state the obvious, “derivative.” They are not assets or actual interests in assets that are connected to a physical location. Rather they are contractual promises that synthesize the consequences of ownership of securities, commodities and currencies. These contracts are struck in cyberspace. Physical location of individuals who make the decision to execute a contract, or of servers who execute contracts pursuant to complex algorithms as if they were derivatives robots, makes no difference. There is no meaningful connection to a tangible asset or a company or government. A trader of the same derivative can sit in New York or London or, for that matter, Tahiti. All that is required is the technology to support the trader (robot or human) and the restaurants and entertainment to satisfy lifestyle needs.
Major European and Asian jurisdictions are well on their way to adopting reform regulation. The question is how these regulations and the US rules fit together. Are there any gaps? Can banks game the jurisdictions without violating rules, as Chairman Gensler once did?
As a practical matter, this will depend on how the CFTC chooses to approach its own jurisdiction. The Dodd-Frank Act wisely ignored technicalities like where a company is organized and where individuals maintain their desks. The Act extends jurisdiction to any activities that have a significant effect on US commerce.
Some months ago, the CFTC issued a proposed guidance on how it would approach multi-jurisdictional issues. At the same time it issued an exemptive order, a policy statement of general applicability that said that it would allow banks and other derivatives traders to transact freely while the cross-jurisdictional issues were sorted out. On July 12, the exemptive order expires. In the interim, instead of working the issues out, other jurisdictions, primarily the Europeans, have complained publicly about the CFTC’s approach, generally saying that the US regulator has overreached. The banks have also complained, warning gravely of burdensome and multiple levels of regulation.
The problem is that all of this has befuddled members of Congress and the press and has made regulators other than Gensler weak in the knees for no reason. As Shakespeare said “it is a tale... full of sound and fury, signifying nothing.”
The Dodd-Frank Act had it right. Jurisdiction is properly broad and the regulators in the various nations should work it out. That is precisely what has happened. Most of the differences have been worked out. These differences are in the form of conflicting rules and overlapping rules, and the conflicts have been agreed upon. What remains is the basic problem of a US party transacting with a foreign party where rules overlap. The obvious answer is that the most conservative, meaning safest, set of rules should prevail. That does not satisfy the banks who dream of a world in which the weakest rules govern. And the foreign jurisdictions realize that the US rules, which are generally safer, will often displace their own.