Nick Shaxson ■ Letter on derivatives: stop the offshore race to the bottom


Wall Street banks trade perhaps half of their derivatives activities through foreign banks. For them, foreign jurisdictions are an obvious escape route from U.S. financial regulations. Last June, Marcus Stanley of Americans for Financial Reform wrote:

On Monday, the U.S. became the first country in the world to require mandatory clearing of many derivatives contracts, a crucial protection in these previously unregulated markets.

But even as this crucial protection takes effect, Wall Street is mobilizing to create a back door escape route. Its goal is to prevent U.S. regulation of derivatives transactions by U.S. companies that are conducted overseas. This loophole could strike at the foundations of financial reform.
. . .
It would create an incentive for global banks to transact their business through whatever jurisdiction has the weakest regulations – a “regulatory haven” to match the tax havens that international corporations already use.

A month later, TJN joined AFR in co-signing a letter to the European Commission and a number of finance ministers, urging them not to adopt proposals that would foster exactly this race to the bottom, by allowing ‘substituted compliance’ (i.e. in countries that get a clean bill of health from the U.S., financial institutions can escape direct U.S. regulation, and quite possibly any meaningful regulation.) The issue is analogous to what happens in tax, when companies fret about so-called ‘double taxation’ – but end up, through the offshore system, finding pathways through the system, to enjoy double non-taxation.

Today, AFR has written an important new letter, containing this:

“The CFTC did not take this advice, and has instead laid out a cross-border regulatory framework in which substituted compliance is available for derivatives transactions between foreign subsidiaries of U.S. entities. Transactions between guaranteed foreign subsidiaries of U.S. entities and foreign entities not tied to a U.S. parent are completely exempted from Dodd-Frank (unless such foreign entities are registered swap dealers). Finally, transactions involving foreign subsidiaries of U.S. entities that are not explicitly guaranteed by the parent are also broadly exempted from Dodd-Frank in cases where such subsidiaries are neither conduits nor swap dealers.”

And it adds:

“A danger in this approach is the possibility that major U.S. financial firms will be able to move most of their derivatives transactions into nominally overseas subsidiaries, giving them a choice between substituted compliance regimes or in some cases permitting them to avoid oversight altogether.”

These arcane moves constitute grave dangers for the global economy. The letter responds to a request for comment on a Staff Advisory issued last November, and adds:

“If the CFTC alters its November staff advisory to permit such an outcome, then major U.S. and global banks conducting transactions on the U.S. market will effectively have their choice of rules under which to operate.
. . .
We thus urge the CFTC to avoid any weakening of the November staff advisory”

We support that, as an absolute minimum.

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