Extraterritoriality: try saying it quickly, three times over

After almost two years since the Dodd-Frank Act (DFA) was put on the statute books, the first swap-related articles finally take effect on 12th October this year. Now everyone can be assured they are trading, clearing and reporting under a common set of rules, right?

Not so. While DFA requires market participants to report OTC trades to Swap Data Repositories (SDR) and introduces conduct business rules, other jurisdictions have not yet finalised their respective regulations. A regulatory conundrum arises: how will rules drawn up in one jurisdiction apply in others (also known as extraterritoriality)?

There are many unanswered questions around extraterritoriality and this is one of the reasons trade bodies like The International Swaps and Derivatives Association (ISDA) are crying out for clarification:

• Will regulators recognise one another’s regimes to ensure continuous trade relationships around the globe?
• Will firms clearing via clearing houses outside their jurisdictions be able to continue to do so?
• When trading across jurisdictions, which of the counterparties is required to do reporting, or is it both? To which SDR will they report?
• If DFA comes into force earlier than other jurisdictions, does a trade need to be cleared at all? Will end-user exemptions come into play or not?

As Larry Thompson, general counsel at The Depository Trust and Clearing Corporation (DTCC), recently pointed out: “Harmonisation of regulations is paramount because, unlike the securities markets, derivatives have no set domicile – these markets and their participants are global and diverse.”

The new regulatory landscape will keep financial institutions under the scrutiny of their domestic regulator, and potentially also under foreign regulators due to extraterritorial reach. The lack of harmonisation across jurisdictions represents a challenge for firms, as does the fact that industry practices are still evolving as regulatory requirements across the globe unfold. Flexibility and adaptability are key but sadly this has always challenged financial institutions.

The pace of these changes makes it difficult to adequately adapt to regulations and, in some cases, is creating rework of analysis already conducted due to changed or additional regulatory requirements. Global regulatory alignment in this matter, therefore, is an absolute necessity to calm fears and reduce uncertainty of market participants.

In the next part of this OTC clearing blog series we will look at implications on collateral management.