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The European Commission and the CFTC reach a Common Path Forward on Derivatives

European Commissioner Michel Barnier and United States Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler today announced a Path Forward regarding their joint understandings on a package of measures for how to approach cross-border derivatives.

Commissioner Barnier said that “our discussions have been long and sometimes difficult, but they have always been close, continuous and collaborative talks between partners and friends.”

Chairman Gensler said, “With these joint understandings, together, we’ve taken another significant step in our mutual journey to bring transparency and lower risk to the swaps market worldwide. I want to thank Commissioner Barnier and all his colleagues for their constructive collaboration throughout this reform process.”

The Path Forward responds to the G20 commitment to lower risk and promote transparency in the over-the-counter (OTC) derivatives markets, which were are at the heart of the financial crisis. The CFTC and the European Commission share a common objective of a steadfast and rigorous implementation of these commitments. Together with the European Securities Market Authority (ESMA), the European Commission (EC) and the United States have made significant progress in their regulatory reforms. Close legislative and regulatory co-ordination and co-operation between the European Commission (EC) and the CFTC have ensured that the rules in place pursue the same objectives and generate the same outcomes. As a result of the joint collaborative effort, in many places, final rules are essentially identical, even though the regulatory calendars are not always synchronized.

As the market subject to these regulations is international, it is acknowledged that, notwithstanding the high degree of similarity that already exists between the respective requirements, without coordination, subjecting the global market to the simultaneous application of each other’s requirements could lead to conflicts of law, inconsistencies, and legal uncertainty. The CFTC and the EC, with ESMA, have worked closely and collaboratively to implement their rules and regulations to avoid this to the greatest extent possible and consistent with international legal principles. The CFTC and the European Commission share the view that jurisdictions and regulators should be able to defer to each other when it is justified by the quality of their respective regulation and enforcement regimes.

For bilateral uncleared swaps, and because EU and US rules for risk mitigation are essentially identical, the CFTC plans to issue no-action relief for certain transaction-based requirements. In this regard, the EU’s system of ‘equivalence’ can be applied to allow market participants to determine their own choice of rules.

For the trading-execution requirement, the CFTC plans to permit foreign boards of trade that have received direct access no-action relief to also list swap contracts for trading by direct access to avoid market and liquidity disruption.

As the markets and regulatory regimes continue to evolve, and in order to ensure a level playing field, promote participation in transparent markets, and promote market efficiency, the CFTC will extend appropriate time-limited transitional relief to certain EU-regulated multilateral trading facilities (MTFs), in the event that the CFTC’s trade execution requirement is triggered before March 15, 2014. Such relief would be available for MTFs that have multilateral trading schemes, a sufficient level of pre- and post-trade price transparency, non-discriminatory access by market participants, and an appropriate level of oversight. The CFTC staff will issue no-action letters to this effect. In addition, the CFTC will consult with the EC in giving consideration to extending regulatory relief to trading platforms that are subject to requirements that achieve regulatory outcomes that are comparable to those achieved by the requirements for SEFs. Both parties will in January 2014 assess progress.

The EC, ESMA, and the CFTC will continue to work together on similar approaches to straight-through-processing and harmonized international rules on margins for uncleared swaps and have essentially identical processes with regard to adopting mandatory clearing obligations and regulating intra-group swaps/derivatives trades. They also share common goals of ensuring that the overseas guaranteed subsidiaries and branches of US and EU persons are not allowed to operate outside of important G20 reforms.

Their approaches for reporting to trade repositories are also very similar and the EC, ESMA and the CFTC will continue to work with each other to resolve remaining issues, such as consistent data fields, access to data, and other issues related to privacy, blocking, and secrecy laws. They will seek to resolve any material issues that may arise in line with the conclusions that may be drawn from discussions in international forums on this subject.

With respect to central counterparties (CCPs), CFTC rules and EMIR are both based on international minimum standards. CCP initial margin coverage is the only key material difference and the parties will work together to reduce any regulatory arbitrage opportunities. They will also endeavour to ensure that CCPs that have not yet been recognised or registered in the US or the EU will be permitted to continue their business operations.

Both sides aim to conclude these discussions as soon as possible, at which stage the substance of relevant relief awarded by the CFTC will be reflected in its guidance relating to substituted compliance, as approved by its principals, while the EU equivalence decisions will have been in place, and where necessary, amended to reflect this partnership. For the future, they have agreed to continue to work collaboratively and to consider any unforeseen implementation effects that might arise in the application of their respective rules.

The EU and the US are leading by example and invite others countries to join this approach to make sure that the G20 commitments will be applied in a sensible and rigorous way to cross-border derivatives trades.