Thursday, May 26, 2011

New Derivatives Rules Would Hurt Competitiveness of US Banks

FT: Derivatives Reform Will Not Prevent Next AIG ; Lawmakers Warning on Derivatives Rules; Banks Anxious Over Fed Regulations

A group of New York lawmakers recently sent a letter to US financial regulators including the Federal Reserve and the Commodity Futures Trading Commission, warning that a newly proposed rule on derivatives under the Dodd-Frank Act would hurt the competitiveness of the US financial institutions. The lawmakers also wrote in a letter that the rule would be “inconsistent with Congressional intent.” It is a margin rule that the lawmakers make an issue of, which applies to US banks as well as their foreign subsidiaries located outside the US. Specifically, the rule requires parties to some derivatives transactions to post cash or securities as collateral or “margin” in order to assure their obligations. Under this rule, foreign subsidiaries also have to collect collateral from their foreign clients.

Unless foreign regulators do not adopt a similar approach, the rule would put foreign subsidiaries of US banks in a disadvantageous position, said the lawmakers. While the lawmakers acknowledged that the new rule would provide important safeguards and make the US financial system more resilient to another financial crisis, they argued that it should not harm the competitiveness of non-US subsidiaries of US banks. Those who oppose express their concerns that under the new rule, more clients will opt to transact with non-US financial institutions in Europe such as Deutsche Bank and Barclays Capital which are not subject to the same rule. Opponents also worry that the rule would tie up capital that could be used for investments and prevent investors from making rational risk management decisions.

On the other hand, those who support the rule emphasize that the margin rule is essential as a measure to prevent future financial crises. Proponents also argue that since exempting foreign subsidiaries of US banks from the margin requirement would put US banks in a disadvantageous position, the same rule should apply both to US banks and their foreign subsidiaries. The US financial regulators defend the extraterritorial application of the rule by saying that it is necessary “because the US parent company’s ownership of the subsidiary is likely to expose the US parent company, as a result of legal, contractual or reputational factors, to the risks of the foreign subsidiary’s derivatives activities”.

Responding to the critics of the rule, US financial regulators have said that the margin rule has not been finalized yet and the problem of regulatory arbitrage could be resolved if regulators in foreign jurisdictions also adopt a similar rule.

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