Barclays case gives U.S. futures regulator more clout on overseas derivatives, funding

By Guest Contributor
July 5, 2012

By Nick Paraskeva

NEW YORK, July 5 (Thomson Reuters Accelus) - The U.S. Commodity Futures Trading Commission’s $200 million settlement with Barclays for manipulation and false reporting of benchmark interest rates not only helped fuel a firestorm that consumed the bank’s top management. It also gives the futures regulator more clout to apply new Dodd-Frank swaps rules to activities abroad despite industry and political opposition, and to make a case against congressional Republicans for a strong enforcement budget.

The CFTC joined the U.S. Justice Department and Britain’s Financial Services Authority (FSA) in settling allegations that Barclays had manipulated Libor interbank rates in London that affect U.S. consumers and markets. The fine paid to the CFTC was the largest monetary penalty in the case, and the enforcement came hard on the heels of the revelation by JPMorgan Chase that it had discovered losses on its UK derivatives transactions that may grow to as much as $9 billion.“People taking out small business loans, student loans and mortgages, as well as big companies involved in complex transactions, all rely on the honesty of benchmark rates like Libor for the cost of borrowings,” said CFTC chairman Gensler announcing the settlement. “Banks must not attempt to influence Libor or other indices based upon concerns about their reputation or the profitability of their trading positions.”

The bank’s submissions to Libor improperly took account of its traders’ own positions in derivatives. Traders in New York, London and Tokyo also requested other banks to submit rates to benefit their own positions. False submissions were also made at the direction of management to protect the firm’s reputation during the financial crisis, when its borrowing rates were higher than other banks. Submissions are meant to reflect a bank’s assessment of rates at which it could borrow interbank funds in a currency.

Fines and funding

Barclays bank was fined a total of $452 million, including $160 million to the U.S. Department of Justice and a £59.5 million ($92.8 million) record fine by the FSA. It is notable that the CFTC fine was twice as big as the FSA’s, despite much of the activity being based in London. Barclays is the first major bank to settle with regulators in the ongoing Libor investigation, and the size of future fines may be higher.

The Justice Department stated that the penalty reflected Barclays being the first bank to provide “extensive cooperation” to the government and disclosing the conduct. “Its efforts have substantially assisted the criminal division in our ongoing investigation of individuals and other financial institutions in this matter,” said Assistant Attorney General Lanny Breuer. The U.K Serious Fraud Office (SFO) is also considering criminal prosecutions.

“The CFTC’s success in uncovering the outrageous manipulation of Libor, and the consequent settlement which will bring to the U.S. Treasury hundreds of millions of dollars, demonstrates the value of that agency,” said Democratic U.S. Rep. Barney Frank, co-author of the Dodd-Frank Act. “Refusal by Republicans to meet the administration’s request for $308 million for CFTC, when the agency has helped bring into the Treasury approximately that amount in one successful prosecution, demonstrates the party is driven not by concern for the deficit but by ideological rigidity,” Frank said.

Republicans in Congress have fought against proposed budget increases for the CFTC, despite pleas from the regulator that the money is needed to meet expanded duties.

In line with U.S. practice, the UK government will propose amendments to ensure that fines paid by financial services firms go to the government, and not as before to the FSA, which reduced the levies that other banks pay. “From now on, the multi-million pound fines paid by banks and others who break the rules will go to the benefit of the public not to other banks,” said British finance minister George Osborne.

London Calling: Cross-Border Derivatives

The CFTC enforcement provides another example of what U.S. regulators have been pointing out: that a string of troubles since the 2008 crisis for U.S.-owned financial institutions was caused by trading done in their London units. “The Barclays matter, the JPMorgan loss and many other illustrations make the case” for international harmonization, CFTC Commissioner Bart Chilton said in support of cross border oversight.

Frank cited reports that JPMorgan may lose billions more than previously estimated on its derivative trading in London. “The very fact that JPMorgan continually has had to upgrade the amount at issue is reminiscent of the problems with A.I.G., another example of derivatives being traded in London by an American institution,” he said.

Unlike in the JPMorgan case where they were defensive, the UK regulators have been equally scathing over Libor. “The Libor scandal has caused a huge blow to the reputation of the banking industry,” said FSA Chairman Adair Turner, at the annual public meeting. “The cynical greed of traders asking their colleagues to falsify their Libor submissions so that they could make bigger profits has justifiably shocked and angered people.”

Andrew Tyrie the Chairman of the UK Parliament Treasury Select Committee, which interviewed ex-CEO Diamond after he resigned, said, “The reputation of Britain’s financial services industry has been severely tarnished.”

“It appears that many banks were involved and Barclays were the first to own up,” he said. “The public’s trust in banks has been even further eroded. Restoring the reputational damage must begin immediately.”

The enforcement comes at a key time in CFTC rulemaking, as the commission considers the extent that new OTC derivatives rules under Dodd-Frank should apply to firms and activities based outside the U.S., known as “extra-territoriality.” The concept has proved controversial with foreign firms who don’t want U.S regulation, and for U.S. firms who trade via UK affiliates, who claim it will drive more business overseas.

“These situations demonstrate that the rules on derivatives put in place by [Dodd-Frank] are an important protection not just for our economy, but for the institutions themselves,” Frank said. “Yet Republicans want such transactions to be immune from any American regulation.” In April, a Republican-led House panel passed the proposed “Swap Jurisdiction Certainty Act,” which if it becomes law would stop CFTC from regulating swaps of U.S. subsidiaries overseas.

Days after the Barclays settlement, the CFTC issued proposed guidance and a policy statement on the cross-border application of swaps rules. This includes the approach it will use to require foreign firms to register in the U.S, and which CFTC rules the foreign firms will need to comply with if already regulated.

The level for a U.S. person to register as a swaps dealer will also be used for a non-U.S. person acting as swap counterparty to U.S. persons. Thus, a foreign entity would be required to register if its swap transactions with U.S. persons are over the minimal threshold levels for U.S. dealers. This exempts persons with swaps under $8 billion from registering, and scheduled to fall to $3 billion after a 2 year phase in period.

A non-U.S. person with swaps above the threshold level must register with U.S. regulators. Thus a foreign firm’s swaps conducted with U.S. persons, or with the overseas branches of U.S. persons, will count toward the de minimis level. Any swaps with non-U.S. persons also need to be counted, where the latter’s obligations are guaranteed by a U.S. person or in a controlled overseas affiliate of a U.S. person.

“It is troubling that this cross-border release was not issued as a rule proposal, but was rather issued as proposed guidance,” said Tim Ryan, chief executive of the industry group Securities Industry and Financial Markets Association. This reflects industry concern that guidance increases uncertainty on whether the provisions could be tightened in future. Guidance also avoids the cost-benefit analysis required for a rule, and which SIFMA has in the past used as the basis for a legal challenge.

CFTC Phase-in and Foreign Regulator Equivalency

CFTC also issued an order on which rules apply to foreign swaps dealers and major swaps participants, and allowing a phase-in period before they apply. It distinguishes between rules that apply at the entity-level, and those at the transaction-level. This is is used to determine the rules that can be exempted from foreign firms, on the basis of their ‘substituted compliance’ with the rules of their own overseas regulator.

Entity-level requirements include capital adequacy, role of a chief compliance officer, risk management, large trader reporting, and record-keeping. Transaction-level requirements include clearing, margin and segregation, trade execution, real-time trade reporting, confirmations, and sales conduct rules.

Foreign swap dealers and major swaps participant can comply with CFTC entity-level rules by substituted compliance with the home regulator. This will be allowed where the foreign regulator’s requirements are comparable to corresponding provisions of the U.S. Commodity Exchange Act and CFTC requirements.

Non-U.S. persons including foreign branches of U.S. firms may comply with their local regulations instead of the CFTC transaction-level and entity-level rules, if certain conditions are met. This includes the foreign firm submitting an application to register as a swaps dealer or a major swaps participant with the National Futures Association (NFA), which is the U.S. self-regulatory organization for the derivatives industry.

CFTC transaction-level rules will still apply to all U.S.-facing swap trades by an overseas person. There is an exemption for swaps between a non-U.S. firm and a non-U.S. person that is guaranteed in the U.S. or that is an affiliated conduit of a U.S person. Swaps between a foreign branch of a U.S. swaps dealer and a non-U.S. person are also not subject to CFTC transaction-level rules.

Within 60 days of applying to NFA, the firm should also provide a compliance plan for implementing each CFTC rule. The plan should state, for each rule, whether the firm seeks a comparability determination of its home regulatory regime, and that it will comply with those local rules. The firm should also provide a description of the rules that are imposed by their home jurisdiction on which the firm seeks comparability.

The rules are effective from the compliance date of the registration rule for swap dealers and major swap participants. For non-U.S. persons and foreign branches of U.S. firms, there is a phase-in period 12 months after the registration proposal is published. The CFTC scheduled a meeting on July 10 to issue final rules on the definition of “swap”, and “security-based swap”, that will allow registration timetable to be specified.

U.S. swap dealers, and major swap participants are also given a phase-in period for entity-level rules only, which expires on January 1, 2013. A U.S. person’s compliance with the business conduct requirements is also phased in to January 1 2013. However swaps by both U.S. and foreign firms with U.S. persons, or foreign branches of U.S. firms, are required to be reported to a swap data repository (SDR) or the CFTC.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. <a href=” ions/regulatory-intelligence/compliance- complete/” target=_new”>Compliance Complete</a> provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)

Nick Paraskeva is principal of Reg-Room LLC (, which provides regulatory information and consultancy. He covers various facets of the banking and securities industry and delivers exclusive analysis through Thomson Reuters. He can be contacted at (212) 217-0403 and Follow Nick on Twitter@regroom.

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