International regulators cool to U.S. swaps spinoff idea

MONTREAL Tue Jun 8, 2010 2:53pm EDT

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MONTREAL (Reuters) - Two top securities regulators at an international conference in Montreal on Tuesday snubbed a U.S. proposal that would force banks to spin off swaps trading operations, arguing it could spark a rush to more lax regions that are not interested in following suit.

Opposition from Hong Kong and the European Union came as U.S. lawmakers try to determine whether their final financial regulation reform should include a plan that would force banks out of the derivatives trading business.

It is unclear whether the controversial measure proposed by U.S. Senator Blanche Lincoln will become law.

If it does, global banks could move to take advantage of differences in regional rules in what is known as regulatory arbitrage, Hong Kong's top securities regulator said on Tuesday.

"Potentially jurisdictions could propose a set of rules that are so onerous that either the banks in that jurisdiction are so disadvantaged, or they will spin off operations into another center," Martin Wheatley, CEO of the Hong Kong Securities and Futures Commission (SFC), told Reuters.

"But people are very sensitive to that. And I think when the final drafting is written people will understand that that is a risk to be avoided," he said of lawmakers, on the sidelines of the International Organization of Securities Commissions (IOSCO) conference in Montreal.

There is some concern because "everything is still in the melting pot at the moment" in the United States, Wheatley added.

The role of banks in the $615-trillion over-the-counter derivatives markets is a central point of contention as legislators globally adopt sweeping reforms meant to avoid a repeat of the 2007-2009 financial crisis and ensuing recession.

Coordination among politicians and regulators in the United States, Europe and elsewhere has emerged as a concern as the interconnected global marketplace is revamped.

"I don't see any clear signals" for proposing a provision like Lincoln's in Europe, Eddy Wymeersch, head of the Committee of European Securities Regulators, said in an interview the sidelines of the IOSCO conference.

"These markets are so globalized. We cannot introduce a system of derivatives that is so different," Wymeersch added. "But there are a couple of points on which there is friction."

The European Union is expected to make formal proposals in July to regulate swaps, including credit default swaps (CDS) like those that dragged down insurance giant American International Group.

Authorities, including IOSCO, would work quickly to close any glaring regulatory gaps that emerge globally, Hong Kong's Wheatley said. "The issue of regulatory arbitrage is less of an issue than regulatory uniformity."

U.S. lawmakers in charge of hashing out the final regulation bill have started negotiating some of the thorniest issues, including potential new derivatives rules.

U.S. Democrat Barney Frank, who will chair the House-Senate panel that will iron out differences on the bill, has said he disagreed with the proposal from Lincoln, who is chairman of the Senate Agriculture Committee.

The Senate bill endorses the proposal, as well as pushing as much OTC derivatives traffic as possible through more accountable and transparent channels such as exchanges and central clearinghouses.

Banks such as JPMorgan Chase & Co and Goldman Sachs Group Inc whose profits would be hurt oppose the Lincoln provision, and so do some regulators. The White House has made clear it does not view the provision -- which may be dropped in conference -- as a high priority.

"This is a huge one where we don't really know what will happen," Jean St-Gelais, chief executive of Quebec's securities regulator and chair of the Canadian Securities Administrators, said of the swaps spinoff proposal.

"This is a question for governments more than regulators as to who regulates what," he added. "Do you allow a bank to do more than typical, classical banking activities?"

The top Democrats leading the U.S. regulatory push are striving to have the bill ready for President Barack Obama to sign into law by early July.

(Additional reporting by Rachelle Younglai and Jennifer Kwan)

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