The 2008 financial crisis demonstrated how interconnected the global financial system is. What began as a real estate bubble fueled by subprime mortgages in many states ballooned into a global financial panic of unprecedented magnitude.
Bundles of poorly underwritten mortgages generated toxic derivatives bets in a global market. When the dust settled, there was broad agreement that not only did we need a new financial regulatory regime, it had to be globally coordinated.
The United States, the European Union, Britain, Japan and other nations should come up with a regulatory regime that works across all borders. This does not have to be the exact same set of rules and regulations, but rather compatible systems, based on a common set of definitions and structures.
The need for international coordination in swaps is particularly important, for many of them involve parties in different countries. One common derivative, for example, an exchange-rate swap, allows parties in the United States to get payments in U.S. dollars while those in Europe are paid in euros. Any variation is the exchange rate between the two currencies is covered by the swap—for a fee.
We agree with European Union Commissioner Michel Barnier who said, “Where the rules of another country are comparable and consistent with the objectives of U.S. law, it is reasonable to expect U.S. authorities to rely on those rules and recognize activities regulated under them as compliant.”
The devil is always in the details. Broad agreements for global coordination can quickly break down into national and international disputes over specific rules. Washington’s main legislative response to the financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act, recognized the global importance of regulation and required that U.S. regulation shall apply when derivatives have “a direct and significant connection with activities in, or effect on, commerce” of the United States.
Our capital markets regulators, the Securities and Exchange Commission and Commodity Futures Trading Commission, are required to either set up their own regulations or accept a foreign system as compliant for all swaps that fit this definition.
Congress instructed the two panels to work together to devise these rules. Despite calls from many experts, however, Congress did not require the two commissions to come to agreement. A simple starting point would be for U.S. regulators to agree on basic constructs—such as the definition of who is a “U.S. person” or what constitutes “effect on commerce.”
Nor did Congress take the more fundamental step of merging the SEC and the CFTC to create one overall capital markets regulator. Merging the two panels has strong bipartisan support—both Treasury Secretary Henry Paulson, of the Bush administration, and former Representative Barney Frank (D-Mass.) proposed it.
Unfortunately, the SEC and CFTC cannot agree on basic concepts. So Washington lacks a unified voice in this global debate. Yet each regulator is moving forward on its own track. However, the CFTC, which has jurisdiction over roughly 95 percent of the market is stuck debating proposals which do not yet have majority support.
The CFTC has delayed implementation of these new rules through July 12, while they try to work out an implementation agreement. However, the agency’s current draft proposal has encountered significant domestic and international pushback.
Recently, for example, the CFTC Chairman Gary Gensler and SEC Chairman Mary Jo White went to Montreal to negotiate with European Union officials to try to find common ground on when to apply U.S. rules and when to apply European rules.
There are reasons to find promise in the structure that the Europeans are contemplating. It is different from the CFTC’s proposal, but may prove more efficient in establishing the best and strongest regulatory system.
The details are crucial to finding a solution, however. With the European regulatory structure not yet finalized, we must remain both vigilant and skeptical that the system will be as robust as some think it will.
However, the CFTC has indicated that it may not be willing to wait for the Europeans and others to finish their process and instead allow the U.S. to go forward alone. Unless action is taken, the CFTC’s proposed rules will go into effect in mid-July. So the law will likely go into effect without the needed regulatory guidance explaining how to comply.
We support speedy adoption of the Dodd-Frank financial rules. In this case, however, international cooperation is so crucial that the CFTC ought to pass another extension, providing additional time for the Europeans and others to coordinate on a set of regulations.
If it has taken almost three years to get the rules right, we can certainly take another three months. What we should not do is allow this current extension to elapse and put into place a legal structure without any regulatory framework.
The CFTC should study the European regulations to make sure that our regulatory system can work with theirs. We should also incorporate the best elements of their system, acknowledging that other nations can often come up with excellent solutions. At no point, however, should we undermine our own regulatory system to make it compliant. We should work with Europe on a race to the top—not the bottom.
Good intentions do not always make for the best regulatory system. For example, a strong regulatory regime that is easily avoided by moving trading activities offshore provides little protection. The goal is to get it right – which in this case requires working with other nations.
While our internal regulatory system is unfortunately so bifurcated that it is difficult for Washington to speak with one voice, that should not stop us from working cooperatively to implement the best system worldwide.
Our solutions will be tested when the next crisis begins. Let’s hope for everyone’s sake that all nations get it right.