The U.S. Commodity Futures Trading Commission (CFTC) released today the keynote address of CFTC Commissioner J. Christopher Giancarlo at the Global Forum for Derivatives Markets, Geneva, Switzerland. In his speech the commissioner predicted grave implications to the U.S. and European economies as a result of a trade war developing in the financial derivatives market, admitting that the reason for confrontation is CFTC overreach.
This speech is a rare display of honesty and clarity for any American regulator that usually doesn’t notice how their actions overstep international boundaries. Mr. Giancarlo of course, had to start by saying that his remarks reflect only his own views and not the views of the CFTC, his fellow commissioners nor those of the CFTC staff.
Commissioner Giancarlo addressed the international forum of major participants and regulators in the derivatives markets on the fifth anniversary of a G-20 Summit, calling for the establishment of a global framework for standardized OTC derivative contracts trading after the 2008 financial crisis. He asked the forum if anyone thought they were actually honoring that commitment or “are we, in fact, building a new 21st century protectionism around regional financial markets, especially in swaps and futures? I am afraid many of you, based on your participation in the markets, already know the answers to those questions, and they do not inspire confidence for the future.”
EU Avoids U.S. Clearinghouses
In regard to swap clearing central counterparties, Mr. Giancarlo noted that the European Commission (EC) has still not recognized U.S. CCPs under the European Market Infrastructure Regulation (EMIR), as it reportedly plans to do for CCPs in India, Japan, Hong Kong, Australia and others. This will make it cost-prohibitive for EU banks to clear through U.S. CCPs, which will be destructive to both U.S. and European economic interests, leading to further market fragmentation and contraction of liquidity, market disruption and dislocation in the global derivatives markets.
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However, instead of accusing the Europeans of singling out the U.S. CCPs, Commissioner Giancarlo acknowledged that the American side was at fault. He said: “I believe my agency, the CFTC, started the current rift in cross-Atlantic swaps cooperation.” And explained further: “CFTC pronouncements say that CFTC trading rules apply anytime and anywhere a U.S. person is a party to a swaps trade or the trade is assisted from U.S. shores. Making things worse, the CFTC swaps trading rules contain a host of peculiar limitations based on practices in the U.S. futures markets that have not been adopted in the EU or anywhere else.”
Global Markets Balkanization
The CFTC approach is to dictate that non-U.S. market operators and participants must abide by the CFTC’s peculiar, one-size-fits-all swaps transaction level rules for trades involving U.S. persons or supported by US-based personnel. The result of which, noted Commissioner Giancarlo, is fragmented global markets where swaps markets have divided into separate trading and liquidity pools, between those in which U.S. persons are able to participate and those in which U.S. persons are shunned.
According to a survey conducted by the International Swaps and Derivatives Association (ISDA), the market for U.S. and euro interest rate swaps (IRS) has split over the past 12 months. Volumes between European and U.S. dealers have declined 77% since the introduction of the US SEF regime. Mr. Giancarlo concluded: “Rather than controlling systemic risk, the fragmentation of global swaps markets into regional ones is increasing risk by Balkanizing pools of trading liquidity and market pricing.”
CFTC Commissioner Giancarlo continued to compare the current situation in the financial markets to the trade war that preceded the Great Depression, following historic U.S. protectionist moves that many historians claim was the trigger for the Second World War. He predicted a disaster for both the U.S. and the EU if measures to reverse the financial blockhead aren’t taken, and called for a new spirit of cooperation. The full-length and interesting speech can be found here.