(Adds background on high-frequency trading)
By Douwe Miedema
WASHINGTON, April 28 The U.S. swaps regulator plans to research whether U.S. banks' overseas trading activity is complying with its rules, a senior official said on Monday, as Wall Street adapts to new rules for the $690 trillion global market.
Scott O'Malia, a Republican member of the Commodity Futures Trading Commision, said he had asked the agency's staff for a legal opinion on whether U.S. banks were possibly evading its rules when doing business in Europe.
"I've asked for a memo or legal guidance from the chairman's staff ... about how people are organizing, and how they are executing trades in Europe," O'Malia said at the Reuters Financial Regulation Summit. "There's just a lot of questions."
O'Malia said the staff agreed to research the issue. It's not clear if the inquiry will lead to any enforcement actions, or further policy changes.
Swaps in the United States must be traded on regulated platforms from the beginning of this year - called Swap Execution Facilities, or SEFs - and U.S. banks need to comply if they do business abroad from an affiliate that is guaranteed by the parent company.
But this means higher costs for clients in Europe - which is lagging behind in its swap trading rules - and many have shifted away their business to subsidiaries of U.S. banks that are not guaranteed, or to non-U.S. banks.
Swaps are used for a broad range of purposes, including to hedge future interest rate expenses and other costs.
"Do people want to trade in Europe to execute without the (rules)? I think the answer at this point is 'yes'. And how will that play out?" O'Malia said at the summit.
No European platforms have yet registered with the CFTC under a new regulation that allows them to comply with European rules - and not the U.S. SEF rules - as long as the two are comparable, O'Malia said. They need to do this by May 15.
Agency staff may request information from banks on the issue as its inquiry proceeds, he added.
Before the crisis, swaps used to be traded largely over the phone in bilateral agreements between buyers and sellers, but the 2010 Dodd-Frank law put an end to that, to make the market less opaque and more resilient to financial shocks.
Much of what the legal opinion will focus on is what constitutes a "guaranteed affiliate", and whether a bank can carve out individual trades even if it is conducting the business from such a unit with such a backstop.
"Do we view it by entity or by transaction ... There are a number of people that have raised both options as this is how we trade," O'Malia said. "This is an area that probably needs a lot closer investigation and oversight," he said.
Three Wall Street trade groups have sued the CFTC over a document laying out how its rules apply when U.S. banks are doing business abroad, or with European and other foreign clients from their U.S. offices.
It was issued as "guidance" by agency staff, and not as a formal rule, which requires a vote from the commissioners. In the lawsuit, the groups accused the CFTC of illegally avoiding a rigorous rulemaking process and failing to study economic impacts of the regulation and its costs to industry.
O'Malia in the past has also accused his agency of dodging proper procedures, and has argued the guidance lacks teeth.
"If it doesn't comply with our guidance, what are you going to do about it? ... guidance is not enforceable," O'Malia said.
MORE RULES COMING
The CFTC is normally headed by a five-person commission, but it is now down to just Acting Chairman Mark Wetjen, a Democrat, and O'Malia, as three commissioner nominees await Senate approval.
Still, the agency plans to keep a high pace in churning out new rules, O'Malia said.
In the coming weeks, he expects the CFTC to clarify how so-called package trades can be traded on SEFs. These complicated deals that comprise more than one swap have so far been exempt from the trading rules, holding down volumes.
The agency also plans to propose a rule to start clearing non-deliverable forwards, a type of swap used in foreign-exchange markets. Clearing is a first step towards SEF trading, and so far, the CFTC only requires certain types of interest rate and credit default swaps to be cleared.
The agency was also still working on possible new rules for high-frequency trading, O'Malia said. The CFTC said in April that it was investigating computerized trading to see if they were breaching its rules.
It also published a study in September that could be the first step to rein in the sector, which is often blamed for market disruptions, and which is again in the spotlight because of a new book by best-selling author Michael Lewis, which says U.S. stock markets are rigged in favour of speed traders.
(Reuters Insider interview with O'Malia: reut.rs/1klAcrP)
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(For more summit stories, see ) (Reporting by Douwe Miedema; Editing by Karey Van Hall and Sandra Maler)