Transatlantic Extraterritoriality and the Regulation of Derivatives: The Need for an Integrated Approach between Washington and Brussels, the Uncertainties of BREXIT and New Directions in the US

Abstract

This paper examines the common approach reached between Commodities Future Trading Commission (CFTC) and the European Commission (EC) on derivatives regulation. The paper reviews issues resolved and explores the issues that remain which are leading to fragmentation of the $553tn global derivatives market. While many differences have been resolved, it would have been better for the markets had both the European Union [EU] and United States [US] adopted a collaborative approach when reforming derivatives after the Financial Crisis (2008). This decision of the EU and US to proceed separately and draw up their own respective versions of the over the counter [OTC] derivatives regulatory landscape was a misstep which affected the efficient operation of capital markets. The question now is whether co-operation between US and EU regulators can survive the disruption posed by Brexit and the Trump Administration and the new directions the UK and US might take in terms of derivatives regulation.

The long-term effect that Brexit may have on the regulation of derivatives will depend on the new post-Brexit relationship that the UK and the EU agree upon. It is essential that the smooth functioning of the international derivatives trading market and the critical role that London plays as the global centre for Euro denominated clearing must continue without regard to whether a political agreement can be reached on the withdrawal of the UK from the EU. A discussion as to the post-Brexit role that the City of London should play in respect of Euro denominated clearing and the services the City performs for EU clearing members and trading venues needs to be had to give the EU the assurance it requires to have oversight over central counterparties (CCPs) operating in third countries (such as post-Brexit UK) that perform systematically important functions for EU clearing members and trading venues.

In the US, if the Trump Administration can reform current CFTC regulation to reduce the extraterritorial impact that current US swaps trading rules have on non-US market participants, this could be beneficial to reduce the fragmentation that is occurring in the global swaps trading pool. It is encouraging to see CFTC Chairman Giancarlo propose implementing a two-tier system that would separate foreign jurisdictions into those that are “comparable” and those that are “non-comparable” in order to afford comparable jurisdictions greater control over their own regulatory matters so long as such matters do not pose a risk to the US financial system. However, such a reform will require Congress to act and they will look to what the EU is doing in respect of its European Market Infrastructure Regulation on derivatives, central counterparties and trade repositories (EMIR 2.2) reforms before committing the CFTC to reducing the control it asserts on non-US market participants. The role of European Security and Markets Authority (ESMA) and its plans to introduce EMIR 2.2 at this juncture will play a pivotal role in determining whether the possibility of further reducing the extraterritorial application of derivatives regulation globally will continue.