Japanese FSA Releases Letter to US Secretary of Treasury on Cross Border OTC Derivatives Reform

Japanese regulator the Financial Services Agency has issued a ministerial-level letter to the US Secretary of Treasury Jacob J. Lew,

Japanese regulator the Financial Services Agency has issued a ministerial-level letter to the US Secretary of Treasury Jacob J. Lew, signed by nine senior government officials from other countries in agreement with the proposals being discussed internationally regarding principles and methods relating to reformation of cross-border OTC derivatives.

Along with the Japanese FSA, the letter included the signatures of:

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Guido Mantega, Minister of Finance for Brazil

Pierre Moscovici, Minister of Finance for France

Taro Aso, Deputy Prime Minister and Minister of Finance, Minister of State for Financial Services for Japan

Michel Barnier, Commissioner for Internal Market and Services for the European Commission

Wolfgang Schauble, Minister of Finance for Germany

Anton Siluanov, Minister of Finance for Russia

Pravin Gordhan, Minister of Finance for South Africa

Eveline Widmer-Schlumpf, Minister of Finance for Switzerland

George Osborne, Chancellor of the Exchequer for the United Kingdom

The letter was copied to:

Chairman of the FSB

The Chairman of the CFTC

The Chairman of the SEC

The Chairman of the US Senate Committee on Agriculture, Nutrition and Forestry

The Chairman of the US House of Representatives Committee on Agriculture

International Co-operation

Although issued by the Japanese FSA, the letter was written collectively and represents the proposals of these nine government officials.

It was highlighted to the US Secretary of Treasury that such officials are already starting to see evidence of fragmentation in this vitally important financial market, as a result of lack of regulatory coordination. The letter expressed concern that without clear direction from global policymakers and regulators, derivatives markets will recede into localized and less efficient structures, impairing the ability of business across the globe to manage risk.

This in turn could dampen liquidity, and impede investment and growth. The countries involved show a common commitment with respect to OTC derivatives reform, and are implementing rules across very different markets with different characteristics and different risk profiles, to support this global initiative.

There is common agreement on the basic principles on which cross-border rules should be based are clear and widely shared.

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An approach in which jurisdictions require that their own domestic regulatory rules be applied to their firms’ derivatives transactions taking place in broadly equivalent regulatory regimes abroad is considered by these government officials as being unsustainable. Market places where firms from all our respective jurisdictions can come together and do business will not be able to function under such burdensome regulatory conditions.

A coherent collective solution is therefore needed for cross-border derivatives, and regulators must work together to avoid outright conflicts in regulation and minimize overlaps as far as possible. In this regard, mutual recognition, substituted compliance, exemptions, or a combination of these would all be a valid approach, and careful consideration should be given with respect to registration requirements for firms operating across borders.

Recent experience shows that these discussions can only proceed if they are based on a shared understanding of the overall outcome being sought. For this reason, we are writing to urge that jurisdictions consider carefully the attached principles to avoid cross-border conflicts and support the Pittsburgh G20 reforms. We hope that these principles might provide a useful foundation for regulatory discussions to make progress.

The intended result of this dialog is that authorities work together to achieve an outcome that meets the principles outlined in the letter.

The principles for consideration are:

Core Principles

1. Cross border rules should be adopted that, if they were replicated by all other jurisdictions, would not result in duplicative or conflicting requirements, or regulatory gaps.

2. This should be achieved through substituted compliance or equivalence arrangements. These will provide regulatory recognition of our mutual efforts to put in place measures to deliver the 2009 Pittsburgh commitments on OTC derivatives. The arrangements will be without prejudice to the right to withhold equivalence or substituted compliance arrangements where regulatory reforms are materially different in outcome.

Substituted compliance is a critical component of these principles and the basis for applying substituted compliance is outlined further below.

Substituted Compliance

Properly regulated cross-jurisdictional derivatives trading is an essential part of an efficient global financial market. The simultaneous application of multiple rules to cross-border activity will result in conflicting, inconsistent or duplicative requirements on market participants, which could be a real barrier to such trading. Where two jurisdictions each have rules which ensure equivalent regulatory outcomes are achieved, requiring a cross-border trade to comply simultaneously with both sets of rules is disruptive, costly and unnecessary.

It also runs the risk of encouraging market fragmentation, as participants are deterred from transacting cross-border. We therefore cannot see a workable regime functioning without a comprehensive global commitment to the principle of substituted compliance, including:

Full scope: Substituted compliance should be available to all market participants for all transaction-level rules and for all entity-level rules where these are applied to legal entities established outside the jurisdiction.

Jurisdiction-level assessment: Access to substituted compliance should be determined on the basis of an objective assessment of equivalence at the jurisdictional level. Where the rules in a foreign jurisdiction have been assessed as equivalent by the home authority, substituted compliance must be available in all circumstances for transactions with, and entities established in, that foreign jurisdiction. There should be no requirement for individual firms to apply for substituted compliance relief.

Outcomes-based approach to equivalence assessment: Differences in national legal regimes and market customs make it unfeasible to achieve identical regulatory frameworks. As such, when assessing equivalence, it will be vital to assess whether the outcome delivered by the rules is equivalent in terms of the protections provided, and not to seek a precise rule-by-rule match up. International standards are key to facilitating the establishment of equivalence between different jurisdictions; international standards should be used as an essential element in assessing equivalence wherever possible.

Regulators should remain vigilant to risks of regulatory arbitrage and be willing to agree more granular international standards where necessary to achieve a consistent implementation.

Registration Requirements

It is regarded by the issuers of the letter that imposition of registration requirements on foreign firms as an unnecessary additional burden. They accept that this approach has already been adopted in some jurisdictions, and do not believe that it will prevent the regulatory outcome envisaged by the G20 in 2009, provided it is accompanied by a full substituted compliance regime applied to those firms. However, a view is held that as a principle, local regulations should not be extended beyond national borders. The issuers expect any deviations from this principle to be narrow, and to exist only where there is a clear and specific justification (for example, this may notably be the case for clearing-houses (CCPs) offering their services in another jurisdiction).


Alongside an effective framework for substituted compliance, there should also be appropriate transitional measures and a reasonable transition period for foreign entities. Particularly in areas where international negotiations are ongoing, these will help address firms’ difficulties in complying with cross-border rules, and ensure a smooth transition to the new framework of global standards.

US Secretary of Treasury
Jacob J Lew

Regulatory cooperation and access to data Access of regulators to trade repository data should be governed by the draft CPSS-IOSCO principles on this issue, to ensure that mutual access to data can be assured as soon as possible. Regulators should be able to access such information from the trade repository directly, in accordance with agreements among regulators, rather than requesting data indirectly via another regulator.

The issuance of this letter demonstrates an international requirement by the countries involved to standardize the means by which OTC derivatives are regulated, to ensure a global unification.

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