Yesterday, officials from nine countries sent a letter to Treasury Secretary Lew out of frustration "at the lack of progress in developing workable cross-border rules as part of reforms of the OTC derivatives market." They noted that they were "already starting to see evidence of fragmentation in this vitally important financial market, as a result of lack of regulatory coordination." This letter is just the most recent attempt by foreign government officials to rein in their American counterparts, whose regulatory appetites appear to be insatiable.
The letter sets forth a number of principles that should govern the regulation of the over-the-counter derivatives market. At the core, these principles envision a regulatory scheme in which regulators share responsibility for the derivatives market, but don't impose duplicative regulations. No one regulator is entitled to set the rules for the whole world. Instead, regulators in one country defer to regulators in another country as long as "the outcome delivered by the rules is equivalent in terms of the protections provided." In making an equivalence determination, it is unrealistic to demand "a precise rule-by-rule match up."
The Securities and Exchange Commission and the Commodity Futures Trading Commission talk a lot about "substituted compliance" and "equivalence," but when top officials elaborate, their understanding of these terms appears more limited than their foreign counterparts' understanding. Former SEC Chairman Elisse Walter, for example, called for an ambiguous "middle ground" approach in which the SEC "would reserve the right to insist upon compliance with our own regulations when necessary." The CFTC's Chairman Gensler has been more aggressive than the SEC in interpreting its Dodd-Frank authority, less willing to surrender control over entities with even the slightest U.S. connection, and unwilling to provide clear rules to govern the agency's extraterritorial reach.
As more reasonable voices at both the SEC and CFTC have argued, the U.S. should not try to be the world's OTC derivatives policeman. It should share the job with foreign regulators, who are willing and eager to do their part.