How will derivatives regulation change in the Trump Administration? During the campaign and since the election, President-elect Trump and his advisors, as well as key Congressional Republicans and other market participants, have suggested that aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), should be rolled back, or even repealed outright. Derivatives regulation, however, has not been the focus of much of the discussion around financial regulation more generally, and some market participants have suggested that it would not necessarily be feasible or desirable to roll back the Dodd-Frank reforms completely. It will likely be some time before we have a clear sense of what changes are likely, and who will be charged with implementing them at various financial regulators. This note is intended to highlight certain areas where it seems to us that regulatory change may be more likely.
It bears remembering that Dodd-Frank itself represented a significant shift in the regulatory approach to derivatives in the United States. Previously, derivatives between institutional market participants were largely unregulated. In the wake of the financial crisis and resulting G-20 commitments, Dodd-Frank attempted to regulate comprehensively the derivatives markets, through such measures as swap dealer registration and required clearing, exchange trading, margin and reporting. Since the passage of Dodd-Frank, US regulatory agencies have implemented (and continue to implement) many of these reforms, and similar reforms have been adopted in other G-20 jurisdictions. The operation and structure of the derivatives markets have fundamentally changed as a result, in ways that may not be easy to unwind.
Certain reforms, however, remain controversial. Still others are not yet implemented, or are still in the process of implementation. The leadership of the regulatory agencies responsible for the Dodd-Frank reforms will change in the new administration, and may reconsider or halt new or expanded regulations that have not yet been implemented, or delay the timing of some reforms. In addition, regulators may also seek to not impose, or to roll back, other more controversial changes.
- Regulation AT. The CFTC’s proposed regulations relating to high-frequency and other electronic trading, known as Regulation AT, have been controversial and criticized by many market participants. It seems likely that this regulation may be delayed, withdrawn or significantly watered down, especially regarding the most debated aspects of the proposal, such as the requirement to submit source code to the CFTC.[1]
- Position Limits. The CFTC has sought for several years to impose new, more restrictive position limits on a range of commodity futures contracts, in the face of significant opposition from market participants. Such an expansion of position limits may be less likely in the new administration. Recently, the CFTC has reproposed these rules, opening up a new comment period that will extend beyond the inauguration and grant the new administration significant influence over the final version of the rule, if any.
- Swap Dealer Threshold. Under Dodd-Frank and current CFTC regulations, the current “de minimis” exception from swap dealer registration of $8 billion is scheduled to be significantly reduced at the end of 2018 to $3 billion. It may now be more likely that the current exemption level is extended or established as the permanent threshold.
- Regulation of Security-Based Swaps. To date, the SEC has not implemented most of the Dodd-Frank reforms relating to security-based swaps. It is not clear whether the new leadership at the SEC will be interested in completing such reforms, and if so on what timetable. At a minimum, the SEC may need to take action as exemptions previously granted from the application of the securities laws to security-based swaps expire.
- Margin for Uncleared Swaps. Implementation of new margin requirements for uncleared swaps continues, with an upcoming March 1, 2017 deadline in the US and other major jurisdictions for required posting of variation margin in transactions with financial entities. In a recent speech, CFTC Commissioner Giancarlo called the deadline “unrealistic” and asked his fellow regulators to consider the “market’s readiness and help ease the transition” to ensure the market’s continuing functionality.[2] In light of the numerous regulators involved, the prospects for any delay in these requirements are uncertain.
- International Cooperation, Conflicts, and Harmonization. Dodd-Frank was enacted in the wake of the financial crisis and commitments among the G-20 countries to implement certain financial reforms. The implementation of Dodd-Frank, particularly the derivatives reforms, has generated a significant amount of conflict and complaints from other countries, and from internationally active institutions, over suggestions that the US requirements have gone too far and have an excessive extraterritorial effect. During the implementation process, there have in particular been disagreements between the US and EU over equivalence of their respective regulatory regimes and cross-border recognition of registrants. Rolling back Dodd-Frank requirements may reduce some of this conflict, but may also raise new questions as to whether US requirements are equivalent to those of other jurisdictions. It may also cause other countries to reconsider aspects of their own regulations. Market participants will worry about whether such changes undermine existing equivalence and/or substituted compliance, or will make it more difficult to obtain equivalence and/or substituted compliance in the future.
- Resolution and Recovery. Congressional Republicans and others have suggested the repeal of Title II of Dodd-Frank, which established an “orderly liquidation authority” under which the FDIC would be authorized to wind-down systemically important institutions, outside of the normal Bankruptcy Code process. Title II reflects the US’s implementation of the goal among regulators in major market jurisdictions of ensuring the orderly resolution of global systematically important financial institutions. While never used, this authority has been criticized as potentially putting taxpayers at risk of supporting “too big to fail” institutions, although that assessment is not universally shared. A related question would be whether amendments could be made to the Bankruptcy Code to facilitate bankruptcy proceedings involving large, systemically important institutions.
Bank regulators in major jurisdictions have required (or proposed to require) changes in derivatives documentation to take into account stays on close-out rights under Title II and other special resolution regimes. (In the US, the banking regulators have proposed but not yet adopted rules of this type.) Market participants have developed resolution stay protocols and other documentation changes to implement such regulations. Those rules may be reconsidered under the new administration, and, accordingly, the protocols and other implementing documentation may need to be delayed or reconsidered as well.
- Trading Requirements. The regime for swap execution facilities, including both the regulatory requirements for such facilities and the mandatory use of such facilities for certain types of derivatives, has, in the view of many market participants, not been entirely successful. Concerns have been raised about market disruption, market fragmentation and onerous regulatory requirements, amid questions about whether the facilities achieve the goals of pre-trade transparency and greater liquidity. The new administration may seek to rethink aspects of these requirements.[3]
- Regulation of Clearing Organizations and Financial Market Infrastructure. The regulation of clearing organizations and other financial market infrastructure has been the focus of significant attention recently in the US and abroad, in light of the requirements to clear many derivatives and concerns about concentration of risk in clearing organizations. Particular focus has been on resolution, recovery and wind-down of such institutions. It is possible the new administration will take different views on some of these issues, perhaps as part of broader consideration of “too-big-to-fail” financial institutions more generally. Although the topic has been less widely discussed, some in Congress have suggested that the Dodd-Frank authority under Title VIII for the enhanced supervision of financial market infrastructures (including clearing organizations and payment systems), as well as the access of such entities to certain Federal Reserve services, could also be reconsidered.
New Commissioners at the Helm
Consistent with past practice, it is expected that the leadership of the key financial regulators for the US derivatives markets, the CFTC and SEC will change.
- At the CFTC, current Democratic Chairman, Timothy G. Massad, has a term expiring in April 2017, and it is expected that he may step down prior to the expiration of his term. Currently, it is anticipated that the lone Republican Commissioner, J. Christopher Giancarlo, will serve as acting chair until the president nominates him or another candidate as the permanent chair. Commissioner Giancarlo has been an active critic of many of the Dodd-Frank reforms discussed above.
- Mary Jo White, chair of the Securities and Exchange Commission (SEC), has announced that she will leave the SEC at the end of the Obama administration. Michael Piwowar, the only Republican SEC Commissioner, may become the acting chairman until Jay Clayton, the nominee for permanent chair, is confirmed.
The new administration will also have the opportunity to fill the vacant Commissioner appointments at both agencies.
Conclusion
There is little clarity at this stage as to how the new administration may approach derivatives regulation. Despite the public statements about repealing or rolling back Dodd-Frank, any change in direction will be complicated by the significant implementation efforts made by regulators and market participations over the years since Dodd-Frank was adopted, which have fundamentally changed the way the derivatives markets operate. The topics noted above represent areas that may be in line for potentially significant changes. Market participants should watch these and other areas as the regulatory (or deregulatory) landscape becomes clearer and initiatives at the Congressional and agency level evolve.
ENDNOTES
[1] For example, during a recent industry speech, CFTC Commissioner Giancarlo reiterated his stance that the source code provision is a “non-starter”. J. Christopher Giancarlo, Commissioner, CFTC, Keynote Address before International Swaps and Derivatives Association, Inc.’s Trade Execution Legal Forum (Dec. 9, 2016).
[2] Id.
[3] CFTC Commissioner Giancarlo, for example, stated his view that it is time to “revisit [the] flawed swap trading rules” and “reverse the tide of global market fragmentation.” Id.
This post comes to us from Shearman & Sterling LLP. It is based on the firm’s memorandum, “Derivatives Regulation in the New Administration,” dated December 19, 2016, and available here.