[House Hearing, 112 Congress]
[From the U.S. Government Printing Office]
LIMITING THE EXTRATERRITORIAL IMPACT
OF TITLE VII OF THE DODD-FRANK ACT
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
SECOND SESSION
__________
FEBRUARY 8, 2012
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-100
U.S. GOVERNMENT PRINTING OFFICE
75-072 WASHINGTON : 2012
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HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee
James H. Clinger, Staff Director and Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
DAVID SCHWEIKERT, Arizona, Vice MAXINE WATERS, California, Ranking
Chairman Member
PETER T. KING, New York GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois BRAD MILLER, North Carolina
JEB HENSARLING, Texas CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin
JOHN CAMPBELL, California ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan JOE DONNELLY, Indiana
KEVIN McCARTHY, California ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico JAMES A. HIMES, Connecticut
BILL POSEY, Florida GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK, AL GREEN, Texas
Pennsylvania KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
ROBERT J. DOLD, Illinois
C O N T E N T S
----------
Page
Hearing held on:
February 8, 2012............................................. 1
Appendix:
February 8, 2012............................................. 29
WITNESSES
Wednesday, February 8, 2012
Allen, Chris, Managing Director, Barclays Capital................ 8
Brummer, Chris, Professor of Law, Georgetown University Law
Center......................................................... 9
Thompson, Don, Managing Director and Associate General Counsel,
JPMorgan Chase & Company....................................... 11
Zubrod, Luke, Director, Chatham Financial........................ 13
APPENDIX
Prepared statements:
Allen, Chris................................................. 30
Brummer, Chris............................................... 43
Thompson, Don................................................ 56
Zubrod, Luke................................................. 62
Additional Material Submitted for the Record
Garrett, Hon. Scott:
Written statement of The Depository Trust & Clearing
Corporation................................................ 66
Letter from the Institute of International Bankers dated
February 7, 2012........................................... 70
Letter from the International Swaps and Derivatives
Association, Inc., dated February 6, 2012.................. 72
Letter to Representative Himes from the Securities Industry
and Financial Markets Association dated February 7, 2012... 74
Letter to Treasury Secretary Geithner, CFTC Chairman Gensler,
Federal Reserve Chairman Bernanke, and SEC Chairman
Schapiro from the New Democrat Coalition dated April 15,
2011....................................................... 76
Letter to Federal Reserve Chairman Bernanke, CFTC Chairman
Gensler, FDIC Chairman Bair, and Acting OCC Comptroller
Walsh from various Members of Congress dated May 17, 2011.. 80
Letter to FDIC Chairman Bair, Federal Reserve Chairman
Bernanke, CFTC Chairman Gensler, Acting OCC Comptroller
Walsh, SEC Chairman Schapiro, FHFA Acting Director DeMarco,
and Hon. Leland Strom from Senator Stabenow and
Representative Lucas dated June 20, 2011................... 83
Letter to Treasury Secretary Geithner from Chairman Bachus
dated August 2, 2011....................................... 87
Letter to CFTC Chairman Gensler, Federal Reserve Chairman
Bernanke, SEC Chairman Schapiro, and FDIC Acting Chairman
Gruenberg from Senator Johnson and Representative Frank
dated October 4, 2011...................................... 90
Letter to Federal Reserve Chairman Bernanke, SEC Chairman
Schapiro, FDIC Acting Chairman Gruenberg, CFTC Chairman
Gensler, and Acting OCC Comptroller Walsh from Senators
Johanns, Vitter, Crapo, and Toomey dated October 17, 2011.. 92
Himes, Hon. James:
Written statement of the ABA Securities Association (ABASA).. 94
Written statement of Representative Gwen Moore............... 97
LIMITING THE EXTRATERRITORIAL
IMPACT OF TITLE VII OF THE
DODD-FRANK ACT
----------
Wednesday, February 8, 2012
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:20 p.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Schweikert,
Royce, Biggert, Hensarling, Neugebauer, Pearce, Posey,
Hayworth, Hurt, Grimm, Stivers, Dold; Waters, Sherman,
Hinojosa, Lynch, Maloney, Moore, Perlmutter, Carson, Himes,
Peters, and Green.
Chairman Garrett. The Subcommittee on Capital Markets and
Government Sponsored Enterprises is called to order. Today's
hearing is titled, ``Limiting the Extraterritorial Impact of
Title VII of the Dodd-Frank Act.''
I welcome the witnesses to the witness table. We will begin
our opening statements. I will recognize myself for 3 minutes,
and then move to the Minority side. So, good morning to the
entire panel. I look forward, as always, to the testimony on
this important topic. And today's hearing is important. Why?
Because it gets to a broader issue that some of us on both
sides of the aisle, quite frankly, have expressed concerns with
regarding the Dodd-Frank Act and the issue of uncertainty.
Uncertainty hurts growth, and it stifles investment.
In this case, companies are uncertain how to respond to the
litany of new rules proposed under Title VII because of the
lack of clarity regarding the extent to which U.S. regulators
intend to apply Title VII to entities in foreign jurisdictions.
So while exact intentions are uncertain, there are indications
that the U.S. regulators intend to have some matter of
extraterritorial application of these rules.
The legislation that Congressman Himes and I introduced,
H.R. 3283, the Swap Jurisdiction Certainty Act, attempts to not
only provide certainty on the application of the Dodd-Frank Act
Title VII rules, but also aims to avoid the negative
consequences that result if Title VII is applied too broadly.
The concerns are not only confined to these shores. Foreign
regulators have concerns as well. The following is a direct
quote from the lead of a Reuters story published earlier this
week: ``The United States is coming to be seen as a global
threat, acting unilaterally and aggressively, with new market
rules that critics say will hurt U.S. firms, foreign banks, and
international markets in one fell swoop.''
Indeed, the list of negative consequences is long if these
issues aren't handled carefully and appropriately. First,
depending on how this extraterritoriality is applied, the
global competitiveness of U.S. firms could be impacted. Non-
U.S. firms may determine it is just too costly to serve
customers and markets. So the overall health and liquidity of
global markets therefore may suffer.
Dual and contradictory regulations will add additional
costs or make it impossible to comply with all the
jurisdictional rules that are out there. Additional costs will
be passed on to whom? The end-users, of course. And that is the
real economy at the end of the day.
The sovereignty of foreign countries may be inappropriately
infringed upon. It might in turn invite regulatory retaliation.
Concerns in this area are bipartisan in nature. Several of my
colleagues across the aisle have joined me in cosponsoring this
bill. In addition, the ranking member of the full Financial
Services Committee joined the Senate Banking Committee chairman
in sending a letter to regulators last October directly
addressing these issues.
In part, the letter reads, ``Congress generally limited the
territorial scope of Title VII to activities within the United
States. The general rules should not be swallowed by the law's
exception which calls for extraterritorial application only
when particular international activities of U.S. firms have a
direct and significant connection with the effect on U.S.
commerce or are designed to evade U.S. rules. We are concerned
that the proposed imposition of margin requirements, in
addition to provisions relating to clearing, trading,
registration, and the treatment of foreign subsidies of U.S.
institutions, all raise questions about consistency with
congressional intent.''
So, H.R. 3283 seeks to answer these questions through clear
statutory language in order to provide certainty to market
participants and international regulators as well.
Once again, I look forward to the testimony today, and I
also look forward to the comments and questions of the sponsor
of this legislation as well, who is taking, obviously, a lead
interest in this issue, and I look to his leadership on this
matter as we go forward.
With that, I yield back my time, and I yield 3 minutes to
Mr. Lynch.
Mr. Lynch. Thank you, Mr. Chairman. I would also like to
thank the witnesses for their willingness to help the committee
with its work. I must say I have grave concerns about the
legislation before us today. This bill before us exempts an
alarmingly large portion of the swaps market from many of the
important requirements of Title VII of the Dodd-Frank Act,
which deals with the over-the-counter derivatives market.
H.R. 3283 would exempt swaps between a U.S. company and a
non-U.S. company or an affiliate from almost all transaction-
level requirements in Title VII, including margin, clearing,
and execution requirements intended to make swaps transactions
safer and more secure.
If you need an example of how this bill would increase
systemic risk to the American economy, look no further than
AIG. AIG Financial Products, which almost single-handedly
crashed the American economy, was a non-U.S. affiliate of a
U.S. company that entered into subprime mortgage credit default
swap transactions with a variety of American and international
companies. When these subprime bonds tanked and it became clear
that AIG could not honor margin calls required by these
contracts, its imminent failure put the entire American economy
in mortal peril. As a result, the American taxpayer pumped $85
billion into AIG to keep it afloat.
Under this bill before the committee, the same transactions
that doomed AIG would receive less oversight--not more--and
create more systemic risk. Even for the standards of this
committee, this is an especially bad idea. Moreover, the
sponsors of this bill argue that exempting these swaps from
Title VII's margin, clearing, and execution provisions will
increase America's competitiveness. That is far from the truth.
I believe it will have the opposite effect, by encouraging U.S.
companies to move their swap business into an overseas
affiliate or subsidiary where they can fully enjoy the
loopholes that this bill creates. This is a major and
unwarranted exception to the carefully crafted Dodd-Frank
reforms, and it creates the possibility of regulatory
arbitrage.
Finally, this bill creates a regulatory race to the bottom
by preventing U.S. regulators from acting until foreign
jurisdictions act first. But of course, as we know, foreign
regulators are similarly afraid to act unless the United States
goes first. America should be the leader in financial
regulation, and not allow a ``you first'' mentality to put
Americans' financial security in jeopardy yet again.
Again, this is a bad idea. And I think we are replanting
the seeds that caused this economic crisis in the first place.
For these reasons, I oppose the bill under consideration today,
and I would urge my colleagues to do the same.
Thank you, Mr. Chairman, and I yield back.
Chairman Garrett. Thank you. The gentleman yields back.
Mr. Schweikert is recognized for 1 minute.
Mr. Schweikert. Thank you, Mr. Chairman. And to our
witnesses, I appreciate you being here. I am hoping, actually--
and I have been looking forward to this hearing--we are about
to have a discussion of the law of unintended consequences. And
as witnesses, as you are speaking, I am hoping I will hear you
touch on everything from jobs to capital availability to
competitiveness. Also, I would love for you to touch on, as we
just heard, AIG, because my understanding is OTS is gone, and
under the regulatory framework we are under right now doesn't
happen, and that we are living in a very, very different world,
and that actually a problem crisis now has already been dealt
with.
The other thing I would also love you to touch on is if the
rules stay the way they are, and we see much of our swaps and
derivative markets move away from us, move to Europe and other
places, are we really systemically that much safer in the
future?
So thank you, Mr. Chairman. I yield back.
Chairman Garrett. The gentleman yields back.
Mr. Himes, the sponsor of the legislation, is recognized
for 3 minutes.
Mr. Himes. Thank you, Mr. Chairman. Thank you for holding
this hearing and for the comity with which we have worked
together on this legislation. I am looking forward to hearing
from our witnesses today on what is a very complicated and
technical topic. I do want to remind all of us that what we are
talking about here is actually pretty esoteric. I suspect my
co-author on this bill would disagree with that statement, but
I actually think Title VII and the dragging of the heretofore
unregulated derivatives market into a regulated environment is
a significant achievement of Dodd-Frank.
The notion that derivatives will clear through
clearinghouses, trade on an exchange when possible, be subject
to margin requirements, be subject to capital requirements, are
very, very powerful remedies to what we saw happen with AIG.
This particular bill does not touch on any of those issues. And
I want to be very clear that this bill is designed really to do
two things. First, perfectly consistent with the congressional
intent of Dodd-Frank, to provide some certainty about which
regulatory regimes apply when you are talking about multiple
countries. Section 722(d) of Dodd-Frank took a crack at that,
at saying that these laws would only apply where there was a
direct and significant connection with activities in the United
States.
Second, this legislation is important, very important for
competitiveness. I will give an example. If prudence would
dictate that a particular swap should have a 5 percent margin
against it, and the United States believes that, and Germany
believes that, we should have a 5 percent margin on that
transaction, not 10 percent. Because if both jurisdictions
impose 5 percent margins and you have 10 percent, that swap is
not getting done. As in so many things related to derivatives,
there is an awful lot more discussion than there is
understanding.
With all due respect to my friend from Massachusetts, this
has absolutely nothing to do with AIG. This bill would preserve
all of the entity protections imposed by Title VII, ensuring
that the manifest irresponsibility that was shown by AIG would
not happen again. Capital requirements for the entity, specific
supervisory obligations, and of course the kinds of oversight
provided because, presumably, AIG would have been deemed to be
systemically important, all that stays in place.
Again, there is an awful lot of misunderstanding here. An
organization I usually appreciate, Americans for Financial
Reform, says that capital requirements would be eliminated for
certain entities abroad. That is not true. Capital requirements
would, in nations that are Basel signatories, defer to the
capital requirements in that nation.
So in conclusion, I would just say this is about
competitiveness, about making sure that banks and nonbanks
understand what jurisdiction they are subject to, and in no way
weakens Title VII, the regulation of the derivatives industry,
or is an effort to roll back Dodd-Frank, something I think
would be a significant mistake.
Thank you, Mr. Chairman. I yield back the balance of my
time.
Chairman Garrett. The gentleman yields back.
The gentleman from Texas, Mr. Hensarling, is now recognized
for 2 minutes.
Mr. Hensarling. Thank you, Mr. Chairman. This is the second
hearing of the Capital Markets Subcommittee dealing with
regulatory overreach and its adverse consequences on jobs and
economic growth. Again, another data point: When you yield
unprecedented, unfettered, historic discretionary powers to the
unelected bureaucracy, they will indeed use it.
Ultimately, we all know, notwithstanding a good jobs report
last month, that there are still almost 13 million of our
fellow countrymen who remain unemployed. Millions more have
simply given up and dropped out of the labor force, which is
why jobs and economic growth continue to be the number one
issue for the American people. So we have to look very
carefully at the subject of regulatory overreach.
Allow me to engage in the time-honored tradition of this
committee of quoting the Chairman of the Federal Reserve when
he agrees with me, and ignoring him when he doesn't: ``If those
margin rules for foreign operations are maintained, and
Europeans and other foreign jurisdictions do not match it, that
would be a significant competitive disadvantage.'' That is a
quote from Fed Chairman Bernanke.
We know that prudential oversight already exists for bank
overseas swap activities by the Fed, and by the OCC. So again,
we don't have any evidence now that international regulators
will adopt the more controversial provisions of Title VII,
putting us at a competitive disadvantage. We know that
prudential regulation already exists, so we must question just
what benefit is to be derived from what is arguably duplicative
and inconsistent regulations.
Significant sectors of the U.S. economy, including
manufacturing, health care, and technology use these
derivatives as a tool to manage risk and compete globally.
Regulations that miss the mark will have a negative impact on
jobs and the economy.
I appreciate the chairman calling this hearing, and I look
forward to hearing the testimony of the witnesses. I yield
back.
Chairman Garrett. The gentleman yields back.
Mr. Royce is recognized for 1 minute.
Mr. Royce. Thank you, Mr. Chairman. There were three
principles put forward in the Pittsburgh G-20 communique in
September of 2009: ``All standardized OTC derivative contracts
should be traded on exchanges and cleared through central
counterparties. OTC derivative contracts should be reported to
trade repositories. And noncentrally cleared contracts should
be subject to higher capital requirements.'' So that is what
the G-20 countries agreed to.
My concern is with the regulatory crusade undertaken by the
CFTC, which is not one geared toward making our markets safer,
but rather an effort to fit an ideological narrative. The
effort led by the CFTC goes against the very idea of
international coordination on this. An overly expansive and
aggressive implementation of Title VII will make our markets
less competitive, and, problematically, they are going to
provide justification for retaliation overseas. This approach
has to be taken in tandem with our allies, not through a shot
across the bow.
Attempting to regulate the global markets from the CFTC
headquarters on 21st Street is not a solution that is going to
work with our allies. So I think the Himes-Garrett legislation
here is the right approach. It brings much needed balance back
into the process. And I yield back.
Chairman Garrett. The gentleman yields back.
The gentlelady from California is recognized for 2 minutes.
Ms. Waters. Thank you very much, Mr. Chairman. As it turns
out, we are getting some complaints from some in the industry
who are alerting us to changes that could take place that were
unanticipated. I don't know, and I have not decided about this
or any other legislation. So I want to hear from the witnesses
today. I want to hear what they have to tell us. And so, I am
going to yield back the balance of my time.
Chairman Garrett. I appreciate that.
Mrs. Biggert is recognized for 1 minute.
Mrs. Biggert. Thank you, Mr. Chairman. I have many concerns
about the unintended consequences of U.S. regulators
steamrolling ahead with the Dodd-Frank Title VII regulations.
Will these regulations introduce more risk into our financial
system, particularly for U.S. insurance companies? Will these
regulations create an unlevel playing field for U.S. financial
institutions with international subsidiaries, putting U.S.
businesses at a competitive disadvantage in the global economy?
And what will the impact of these regulations be on our U.S.
economy? All these issues must be thoroughly vetted before the
Federal regulators take action.
I hope that today's hearing will shed light on the need for
an internationally agreed upon regulatory regime, especially
with our U.S. trading partners. I yield back.
Chairman Garrett. And the gentlelady yields back.
Mr. Grimm is now recognized for 1 minute.
Mr. Grimm. Thank you, Mr. Chairman. I appreciate you
calling this hearing to examine the efforts and clarify the
reach of the derivatives title of Dodd-Frank and what it will
do to business conducted outside the United States. I think at
a time of both increased global competition and growing
regulation, it is imperative that we ensure that new rules
being implemented under Dodd-Frank do not subject American
firms to double, and, in many cases, redundant regulations on
overseas transactions. These redundancies will serve no purpose
but to put U.S. firms at an enormous disadvantage in the global
marketplace, and possibly encourage regulatory arbitrage, which
could put the worldwide financial system at risk.
I look forward to hearing our witnesses' thoughts on the
legislation before us, and I truly hope that our regulators are
paying attention to the discussions that we are having here
today, and take it into account as they move forward with their
rulemaking. With that, I yield back the balance of my time.
Chairman Garrett. Mr. Perlmutter is recognized for 2
minutes.
Mr. Perlmutter. Thank you, Mr. Chairman. I am sympathetic
to the issues raised by Mr. Himes and the chairman. And I am
glad we are highlighting these issues at today's hearing,
although legislating, at this point, may be premature. It is
important that we do not competitively disadvantage or penalize
U.S. financial institutions just because the United States is
further along in financial reform than others in Europe and
Asia. Our rules should be constructed so foreign businesses
still want to conduct business with U.S. financial institutions
abroad.
Undoubtedly, imposing strict margin requirements on certain
trades done abroad that only apply to U.S. financial
institutions would place the U.S. institutions at a
disadvantage because foreign businesses will choose to transact
business with foreign institutions, where their rules don't
apply.
But I feel like there has been some amnesia reflected on
the committee because I still have nightmares surrounding the
events of 2008 and the financial crisis. I do not want to
legislate broad exemptions or carveouts that could potentially
bring down our financial system and the economy. If our
financial institutions are going to stand behind the trades
conducted by their foreign subsidiaries, we must ensure that
they are adequately capitalized and protected so taxpayers,
depositors, and shareholders are not at risk. With that, I
yield back to the Chair.
Chairman Garrett. I thank the gentleman.
The gentleman yields back. Mr. Dold is recognized for the
final 1 minute.
Mr. Dold. Thank you, Mr. Chairman, and I certainly thank
you for calling this important hearing. In listening to my
colleague from Colorado, I want to agree that we don't want to
have unintended consequences jeopardize American financial
institutions abroad. And when we look at the global marketplace
today, it is probably flatter than it has ever been. Certainly
what we don't need is to make sure that U.S. financial
institutions are operating from a disadvantage.
What I can tell you is that when we look at a 2,400-page
bill, inevitably in those 2,400 pages there are going to be
mistakes that are made, couple with the idea that we are going
to have literally thousands of pages of regulation on top of it
trying to interpret that law. Inevitably, there are going to be
mistakes that will be made.
The task that we have is to try to make sure that we
rectify some of those mistakes so that we aren't putting
American institutions at a disadvantage. And certainly the
CFTC, in terms of its interpretations, may simply be doing
that.
So I want to thank my colleagues on the other side of the
aisle for this bipartisan piece of legislation and for their
leadership, and I look forward to hearing from our witnesses
today.
Chairman Garrett. Thank you. The gentleman yields back.
Now, we will turn to our panel. And as we turn to the
panel, you will see that you have a piece of bipartisan
legislation before you. And you can see from the opening
statements today some supportive positions, but also some
concerned positions, and also some open minds as we begin to
look into something that is, as Mr. Himes said, a fairly
technical piece of legislation before us.
So with that, we will turn to our first witness. And of
course, the entire written testimony of all of the witnesses
will be made a part of the record. We are looking to you for 5
minutes of testimony.
And the first will be Mr. Chris Allen, managing director
over at Barclays. Good afternoon, Mr. Allen.
STATEMENT OF CHRIS ALLEN, MANAGING DIRECTOR, BARCLAYS CAPITAL
Mr. Allen. Good afternoon, Chairman Garrett, Ranking Member
Waters, and members of the subcommittee. I thank you for the
opportunity to testify today. My name is Chris Allen, and I am
managing director of Barclays Bank PLC based in London. I head
the global markets legal group for the U.K. and Europe, and
have been actively involved in Barclays' implementation of
global regulatory reform. I would like to start off by thanking
the committee for the leadership they have shown in trying to
get this right.
We strongly support the proposed bill, and believe the
objectives of Title VII would be best served if this measure is
enacted. As U.S. financial reform regulations are being
finalized, there is concern that U.S. regulators are
considering applying Dodd-Frank's swap dealer and other
substantive requirements to non-U.S. aspects of a firm's global
businesses. If these reforms are not modified, they will
subject foreign firms and non-U.S. affiliates of U.S. firms to
duplicative, inconsistent, and sometimes contradictory
regulatory requirements.
This is best illustrated by example. A firm may be required
to execute a trade via a swap execution facility in the United
States while simultaneously being under an obligation to
execute the same trade via the European concept of an organized
trading facility. The European rules are at an early stage of
development. But to the extent that the rules end up looking
different, firms may be presented with the dilemma of not being
able to comply with both sets of regulations at the same time.
Also concerning, an overly expansive application of Title
VII could place global firms at material competitive
disadvantage. If a firm which is conducting business from for
example, Asia, with a client also based in Asia, is required to
apply U.S. rules such as the clearing rules, while local
competitors are under no such obligation by virtue of not being
U.S. registrants, then the firm subjected to the U.S. rules
will struggle to compete successfully.
Many global firms transact across the world using a single
entity structure; i.e., one company throughout the world. U.S.
extraterritorial overreach will cause firms to have to
reconsider the viability of that model in favor of local
subsidiaries in order to avoid regulatory overlap.
Why does that matter? First, it is likely to create hurdles
for U.S. end-users seeking direct access to overseas markets,
since firms may be concerned with establishing a U.S.
connection which would bring them within the scope of Title
VII. Also, there would be an increased likelihood of back-to-
back transactions within firms offering access to those
overseas markets, making such access more expensive for end-
users. It is also unlikely that such an approach would enhance
global consolidated supervision of firms and their swaps
businesses.
We also note that the CFTC is likely to require firms to
register as swap dealers prior to finalizing its
extraterritoriality guidance; i.e., firms will be registering
without knowing the global impact of that registration.
Turning to the proposed bill, we believe that it
appropriately reflects the jurisdictional intent of the Dodd-
Frank statute and serves the effective and transparent
oversight of the global swaps market without having unnecessary
negative impact. Specifically, we support the bill's aim of
dividing the substantive Dodd-Frank requirements into entity-
level requirements, such as those relating to capital or risk
management requirements, and then transaction-level
requirements such as clearing or public reporting.
Where comparable home company country entity-level
requirements exist, such as in relation to capital, compliance
with those requirements should satisfy Dodd-Frank. U.S.
transaction-level requirements would apply to trades with U.S.
customers, but local foreign requirements would apply to trades
between foreign entities.
That brings me briefly to the Volcker Rule. In our view,
the proposed limitations on proprietary trading and the fund
activities go beyond what is required by the statute and would
have severe extraterritorial consequences that were not
intended by Congress. The various exceptions in Volcker are, in
our opinion, insufficient to avoid extraterritorial overreach.
This is not just a case of the rest of the world playing
catch-up. In the U.K., the Independent Commission on Banking
released a proposal that specifically studied and determined
that the Volcker Rule, as passed in the Dodd-Frank Act, was not
necessary when evaluated in light of other systemic risk
management measures the U.K. is instituting. Without revisions,
the Volcker Rule is likely to decrease foreign investments in
the United States, reduce investment opportunities for U.S.
pension funds, reduce liquidity and market opportunity for
issuing companies, and reduce the willingness of international
financial institutions to trade with U.S. counterparties. All
of this risks encouraging alternative financial centers to
develop outside of the United States, and ultimately results in
jobs and transactions moving overseas.
In conclusion, Barclays appreciates the opportunity to
testify today and your attention to these important issues
under Dodd-Frank. We encourage you to continue to work with the
CFTC, the SEC, and prudential regulators to ensure that Dodd-
Frank is implemented in a balanced and orderly manner, making
efficient use of supervisory resources and promoting
international comity. Thank you, Mr. Chairman.
[The prepared statement of Mr. Allen can be found on page
30 of the appendix.]
Chairman Garrett. And I thank you.
Next, from Georgetown, we have Dr. Brummer.
STATEMENT OF CHRIS BRUMMER, PROFESSOR OF LAW, GEORGETOWN
UNIVERSITY LAW CENTER
Mr. Brummer. Chairman Garrett, members of the subcommittee,
my name is Chris Brummer, and I am a professor at Georgetown
Law School, where I teach international finance--
Mr. Perlmutter. Pull that microphone closer.
Mr. Brummer. It is very rare that a law professor is ever
asked to speak louder or to speak more.
Mr. Perlmutter. We are older than most of your students.
Mr. Brummer. Indeed. Indeed. My name is Chris Brummer, and
I am a law professor at Georgetown. And I teach international
finance and securities regulation. I have worked in London with
Cravath, Swaine & Moore, and I serve periodically on NASDAQ
delisting panels, as well as at the Milken Institute's Center
for Financial Market Understanding. But this is the first time
I have had the honor, as can you tell, to talk to you today.
And thank you for the invitation.
Each great failure of 2008, whether it be Fannie Mae,
Freddie Mac, Lehman Brothers, or Countrywide held important
lessons for the country, and AIG was no exception. Its tragic
downfall illustrated, perhaps above all else, just what happens
when complex or opaque transactions fall through the regulatory
cracks, even when they take place in far-flung parts of the
world.
Regulated by a weak and underfunded OTS, and escaping
meaningful oversight in London and France, the insurance
giant's affiliates were able to create and write credit default
swaps that, when combined with poor lending practices,
ultimately toppled the international conglomerate when its bets
went wrong, and at a cost of $85 billion for taxpayers.
To plug these gaps made apparent by AIG and other bailed-
out institutions, Congress passed the Dodd-Frank Act, which
sought to enhance not only entity-level, but also transaction-
level credit quality in an effort to help prevent future
financial crises. Two key elements of these efforts were: one,
to regulate some of the, up to then, largely unregulated
derivatives transactions which had caused and contributed to
the crisis; and two, to direct supervisory agencies most
familiar with the transactions, in this case the SEC and the
CFTC, to take a more active role alongside traditional
prudential regulators in the oversight of such instruments.
Title VII is an important part of the overall reform
package. Essentially, it is designed to move the United States
toward a new system of regulation, with margin requirements to
enhance the credit quality of swap transactions and provide a
buffer against losses. It includes a push towards centralized
clearinghouses to reduce counterparty default risk, and to
allocate losses and reduce the likelihood of bailouts, and to
ensure that credit risk is supported by realtime mark-to-market
benchmarking. It also includes a move from over-the-counter
trading to centralized exchanges in order to facilitate
standardization, ensure price discovery, and increase
competition.
And these efforts have not been made in a vacuum. In the
wake of 2008, G-20 countries, of course, have directed their
attention to the task of reforming the international regulatory
system and committed to a variety of goals including increased
standardization and trading of over-the-counter derivatives,
exchange and electronic platform trading, capital requirements,
and reporting to trade repositories. However, up to this point
even now, relatively few prescriptive standards have been
articulated at the international level.
The Dodd-Frank Act represents an effort to lead by example,
but its approach has been in certain notable regards
unilateral. We have sought to lead by example, but we have also
exported, or at least sought to export, our own regulatory
preferences by leveraging our own formidable capital markets.
From the standpoint of financial diplomacy, this particular
approach can serve an important purpose, both as a means of
cross-border negotiation and to help get the ball rolling on
international standards-setting that, as we have all seen, can
be quite protracted.
But unilateralism carries risks that have only grown as
financial markets have become more globalized. Regulated
entities may seek to avoid your shores, creating competitive
disadvantages, as I am sure we will hear even more about
momentarily. Foreign regulators can, if not retaliate, at least
use your own unilateralism as a kind of precedent in their own
territorially-based regulation. And in the future,
collaborative efforts between regulators can be undermined. So
a balance has to be met between financial stability, comity,
and pragmatism.
The particular approach in this bill carries the promise of
rationalizing internationally the transactions between banks,
but it carries the danger of rolling back all of the
transaction-based progress that I had mentioned before.
For that reason, in my written testimony I had expressed my
own confidence in a more thoughtful and calibrated mutual
recognition regime that is in the legislation standards for
capital. I think a blanket carte blanche allows an offshore
financial center in the future, or a country from Bangalore to
Syria to open up its own haven for low-level regulation, and in
doing so creates certain kinds of risks that could,
unfortunately, bring us back to 2008. I think we do need to
engage our international counterparts. It is essential. But we
have to do so in a thoughtful way. And part of the bill, I
think, moves us in the right direction, and quite frankly, part
of the bill does not. Thank you.
[The prepared statement of Dr. Brummer can be found on page
43 of the appendix.]
Chairman Garrett. Thank you, Professor.
Mr. Thompson is welcomed back and recognized for 5 minutes.
STATEMENT OF DON THOMPSON, MANAGING DIRECTOR AND ASSOCIATE
GENERAL COUNSEL, JPMORGAN CHASE & COMPANY
Mr. Thompson. Thank you, Chairman Garrett. My name is Don
Thompson. As the head of the derivatives legal team at JPMorgan
Chase, I am responsible for leading the firm's implementation
efforts of Title VII. I would like to thank the committee for
inviting me to testify today on the extraterritorial
application of Title VII. And I look forward to addressing the
concerns addressed by Congressman Lynch and others about AIG.
This is an issue of the highest priority to our firm and to
the competitiveness of the American banks internationally.
Section 722 of Dodd-Frank states that Title VII should not
apply outside the United States unless foreign activity has a
direct and significant connection with activities and/or
effects on commerce of the United States. The interpretation of
this phrase is crucial because swap markets are global.
Since Dodd-Frank passed, bipartisan letters from numerous
Members of Congress have clarified that the intent of Congress
is to not apply Title VII extraterritorially absent
extraordinary circumstances. Notwithstanding these expressions
of congressional intent, there are reasons for concern based
upon the current state of the regulatory discussion.
Today, I will focus on three important points related to
this debate. First, the extraterritorial application of Title
VII would create competitive disadvantages for U.S. firms. U.S.
banking regulation has long recognized and preserved the
ability of U.S. firms to compete on a level playing field in
the international markets. If Title VII applies to our overseas
operations serving European or Asian clients, but not to our
European or Asian competitors, U.S. banks will lose much of
this business. This ultimately will have a negative effect on
the competitiveness of U.S. banks, U.S. job creation, and
economic growth. Significantly, losing many of our non-U.S.
customers would also deprive us of valuable diversification in
our credit exposures. This would actually be risk-increasing to
our firm rather than risk-reducing.
Second, global harmonization is not the answer to this
competitive disadvantage problem. We are aware that regulators
are attempting to harmonize derivatives rules globally. These
efforts are important to ensure against arbitrage and adverse
competitive impact, but practical impediments to harmonization
make this an unreliable solution to the competitiveness
problem. Putting aside for a moment the fact that perfect
harmonization will probably never be achieved, even with
European regulators, it is reasonable to expect that there will
be severe differences in the approach to derivatives regulation
in Asia, Latin America, and other important markets around the
globe. The timing of harmonization is also a problem. Europe is
on a much longer timetable than the United States, and the rest
of the world is even further behind. Applying Title VII
extraterritorially would put U.S. firms at a significant
disadvantage while the rest of the world catches up, and many
customer relationships will be damaged or lost in the gap
period.
Third, it is important to note that a prudential
supervisory framework with respect to U.S. banks already exists
and is effective. The stated rationale for an aggressive,
expansive application of Title VII to the foreign swap activity
of U.S. banks with their foreign clients is the potential to
import excessive risk back into the United States. Proponents
of this view cite the overseas swap activities of AIG, but this
rationale no longer holds true for a number of reasons.
First, the activities of U.S. banks outside the United
States, including their swap activities, are already subject to
a robust prudential supervisory regime that is administered by
the Fed and the OCC. It is important to note that virtually all
U.S. swap dealers are banks, or affiliates of banks, or bank
holding companies, and are thus subject to this regime.
Second, the regulatory regime for swaps has changed
dramatically since 2008 and AIG. Major participants in the
market now, because of Title VII, are required to register as
swap dealers or major swap participants. This requires them to
comply with requirements for sound risk management practices,
minimum capital standards, and full regulatory transparency.
Under these mandates, AIG would have been subject to this
regulatory regime, and would not have been able to incur the
exposures that led to the firm's demise. As such, an
overreaching application of Title VII is not necessary to
protect the U.S. financial system.
Finally, I would like to mention the Himes-Garrett bill. We
believe the Himes-Garrett bill is a sensible and workable
solution to these problems. By maintaining the tough entity-
level regulatory framework for all swap dealer activity, even
that outside the United States, it achieves the dual goal of
providing important safeguards for the U.S. financial system
while ensuring that U.S. firms can compete on a level playing
field in the global marketplace.
JPMorgan is committed to working with Congress, regulators,
and industry participants to ensure that Title VII is
implemented appropriately. I look forward to answering your
questions.
[The prepared statement of Mr. Thompson can be found on
page 56 of the appendix.]
Chairman Garrett. All right. Thank you.
From Chatham Financial, Mr. Zubrod, you are recognized for
5 minutes.
STATEMENT OF LUKE ZUBROD, DIRECTOR, CHATHAM FINANCIAL
Mr. Zubrod. Thank you. Good afternoon, Chairman Garrett,
and members of the subcommittee. I thank you for the
opportunity to testify today as the subcommittee considers
legislation to limit the extraterritorial impact of Title VII
of the Dodd-Frank Act.
My name is Luke Zubrod, and I am a director at Chatham
Financial. Today, Chatham speaks on behalf of the Coalition for
Derivatives End-Users. The Coalition represents thousands of
companies across the United States that utilize over-the-
counter derivatives to manage day-to-day business risks.
Chatham is an independent service provider to businesses that
use derivatives to manage interest rate, foreign currency, and
commodity risks. A global firm based in Pennsylvania, Chatham
serves as a trusted adviser to over a thousand end-user clients
ranging from Fortune 100 companies to small businesses. Our
clients are located in 46 States, including every State
represented by the members of this subcommittee. Many of them
operate globally. And we serve them from offices in the United
States, Europe, and Asia. The Coalition has long supported the
efforts of this subcommittee to mitigate systemic risk and
increase transparency in the derivatives market.
Additionally, we have appreciated the bipartisan efforts of
this subcommittee to ensure that end-users of derivatives are
not unnecessarily burdened by new regulation. Throughout the
legislative and regulatory debates, end-users have expressed
concerns to Congress and to regulators about a number of
issues, most notably, the imposition of government-mandated
margin requirements on end-user transactions and the regulation
of an end-users inter-affiliate transactions.
In addition to these regulatory requirements that would
directly burden end-users, the Coalition has raised concerns
about regulatory actions that could indirectly burden end-users
by making risk management more expensive.
We have, for example, expressed concerns that certain
derivatives-related proposals by the Basel Committee on Banking
Supervision could deter end-users from managing their risks or
could make it materially less efficient to do so.
Today, we add to these concerns by highlighting the ways in
which an expansive extraterritorial application of Title VII
could adversely impact end-users. Global companies often manage
risks arising from their foreign operations by executing hedges
out of the foreign subsidiaries that are actually exposed to
those risks. Such entities often have relationships with both
foreign and U.S. banks. Having a robust pool of bank
counterparties enables end-users to enjoy numerous benefits,
including achieving efficient market pricing and diversifying
counterparty exposure.
Importantly, and as I elaborate upon in my written
testimony, the transactions end-users execute abroad are not
designed to evade U.S. law; they are so executed for important
business, legal, and strategic reasons. Because it is
practically infeasible to perfectly align U.S. and foreign
rules, expansive extraterritorial application of Title VII
could create structural disincentives for end-users to transact
with counterparties that are subject to U.S. law. Such
disincentives could lead foreign end-users or the foreign
subsidiaries of U.S. end-users to transact with a smaller
potential pool of counterparties, thus reducing competition and
liquidity, increasing pricing, and concentrating counterparty
exposure. Measures banks may take to limit competitive
disadvantages that result from expansive extraterritorial
application of Title VII would inevitably increase costs for
end-users.
Additionally, the expansive application of these same
requirements to foreign banks operating in the United States
could further impact U.S. end-users operating domestically.
U.S. end-users presently transact with a wide array of banking
partners, including both U.S. and foreign banks. In order to
avoid the duplicative application of U.S. and home-country law
to transactions executed with non-U.S. end-users, foreign banks
have incentives to spin off their U.S. operations into
separately capitalized subsidiaries. This would adversely
impact the end-users in numerous ways, which I elaborate upon
in my written testimony. In essence, it would likely make
hedging risk more expensive and more burdensome. In effect,
expansive extraterritorial application of Title VII could
undermine end-users' ability to manage risk efficiently, both
when they transact domestically and abroad.
We therefore appreciate this subcommittee's consideration
of legislation that would clarify the territorial scope of U.S.
law. Proposals such as the Himes-Garrett bill will increase
certainty for market participants and resolve inevitable
conflicts that would result from overlapping regulations in
foreign jurisdictions.
We acknowledge the complexity of the task before
policymakers in considering the appropriate boundaries of U.S.
law, and believe the Himes-Garrett bill thoughtfully recognizes
the need to defer entity-level regulations to home-country
regulators, while clarifying U.S. transaction-level
requirements apply only in circumstances in which there is a
U.S. counterparty.
We appreciate your attention to these concerns, and look
forward to continuing to support the subcommittee's efforts to
ensure that the derivatives markets are both safe and
efficient.
Thank you for the opportunity to testify today. And I am
happy to address any questions you may have.
[The prepared statement of Mr. Zubrod can be found on page
62 of the appendix.]
Chairman Garrett. Great. I appreciate your testimony.
I have just been advised that we are going to have votes in
a little while, so I am going to try to keep everybody right to
their 5-minute time limit so that everybody here gets the best
chance possible on their time for questioning. So I will
recognize myself, and also abide by the 5 minutes.
Running down the line, thanks, Mr. Zubrod, on this point.
You said that companies, investment companies would invest
overseas for strategic reasons, and not to avoid foreign law,
or in this case U.S. law, right?
Mr. Zubrod. That is right.
Chairman Garrett. Okay. They do that now. But your argument
would be that if you did have an onerous anticompetitive
position, would that change, that they might change from
strategic purposes of investment to trying to avoid U.S. law in
the future?
Mr. Zubrod. I think if the law is applied expansively
abroad, it would ultimately be a cost issue for end-users.
Chairman Garrett. So that is part of the strategic decision
then at that point. It is cheaper to do it over here than to
comply is part of the strategic--okay. A second question on
that would be--and anybody else on the panel can chime in on
this--when they do do that, without the expansiveness of the
regulation, to advocate for a minute for that position, when
they do make that strategic position, does that potentially
have a direct and significant impact on the United States?
Mr. Zubrod. I think it does not. I think when end-users
transact abroad with, for example, the foreign branches of U.S.
banks, those foreign branches of U.S. banks, of course the key
concern here is could that activity potentially transmit risk
back to the United States? And I think there you have to look
at the entity-level requirements that are imposed on that
foreign branch.
Chairman Garrett. Okay.
Mr. Zubrod. And I think you would look and say those are
robust.
Chairman Garrett. So maybe just moving down, Mr. Thompson,
following along that line of thinking then, or that discussion,
part of the seminal question is to define--or the understanding
of what that term ``direct and significant impact'' would be, I
guess, right, under Dodd-Frank? How would you define that?
Would it require that you have a material impact upon the U.S.
financial markets, a material impact upon the U.S. economy to
fall under that definition? Is that appropriate?
Mr. Thompson. Unfortunately, the direct and significant
test has no direct analog in any other statute that we have
been able to identify. There are some which are similar, but
none uses the exact language. So we don't have the benefit of
court cases to interpret it.
In my mind, though, it implies something other than a U.S.
firm losing money on a particular swap with a particular client
because there is no margin associated with that particular
transaction. I think it needs to be something that rises to the
level where it affects not just the creditworthiness of a
particular institution, but there are ripple effects for the
financial system as a whole.
Chairman Garrett. Okay. Great. Dr. Brummer or Mr. Allen,
would you like to chime in on that? Dr. Brummer?
Mr. Brummer. Sure. It is absolutely true that we don't have
any direct analog. However, effects-based regulation,
effectively Congress regulating internationally when certain
activities have an impact here, that is, at least under
international law, quite common. I would say that in this
particular instance where you have a parent company perhaps
guaranteeing the swaps of a foreign entity, and where those
swaps--when bets, quite frankly, go wrong on those swaps and
could imperil the financial health of Parentco here in the
United States, it is hard for me to imagine a situation where
that is not having a direct effect in the United States.
I think it is worthwhile to think about whether or not, in
the absence of Title VII's transactional requirements, what we
have here in the United States for Parentco would be sufficient
under, say, just Regulation K or the OCC, many of which--where
you have under Regulation K, sure, you have capital
requirements, but even those capital requirements under Reg K
were originally envisioned in a world which, if you go through
Reg K and 210 and other provisions, there are no references
made to, say, derivatives activities. When you look at the
permitted activities of a foreign--
Chairman Garrett. And I am going to have to cut you short
since I am going to abide by my own rule.
Mr. Allen, do you want to comment on this? And if there is
uncertainty, as we hear from the panel so far as to that
terminology, what have you--what is the cost, legal,
operational, or otherwise, to that uncertainty for firms such
as yours not knowing as far as whether the swap is going to be
subject to it or not then?
Mr. Allen. I think in order to answer the question, it is
useful to go to the issue of the entity-level versus the
transactional-level basis of regulation. The reason I say that
is that when one looks at the question of the safety and
soundness body of regulation embodied most notably through
capital, I don't think there is any suggestion under the bill,
or more generally, that there should be deference or deferring
to overseas regulators in circumstances where those regulations
are less robust. And in fact, I have heard members comment that
the European regulatory agenda, for example, is somewhat behind
the United States in terms of implementation of those reforms.
That is not necessarily the case.
In fact, I don't think that is the case at all in relation
to capital. When it comes to the transaction-level regulation,
I think it is absolutely right that to the extent that there is
a U.S. nexus, derived by virtue of the fact that, for example,
the one client is based in the United States, then absolutely
the CFTC or the SEC rules, as appropriate, should be the ones
that apply. But I think the point is that they shouldn't apply
in circumstances where the activity is exclusively outside the
United States.
Chairman Garrett. Thank you. Gotcha. I thank the gentleman.
Mr. Lynch is recognized for 5 minutes.
Mr. Lynch. Thank you Mr. Chairman. If I listened closely
enough, it seems to me what people are saying is that in order
to remove the uncertainty in the regulatory process that Dodd-
Frank Title VII, Section 722 creates, in order to remove that
uncertainty we are just going to exempt all the stuff from
regulation, so there won't be any uncertainty because none of
it will apply. That is the solution here. And that exception
that you are creating swallows the rule entirely.
Under H.R. 3283, its provision would exempt foreign
affiliates of U.S. banks from basically all the major
protections against derivative risk contained in Title VII. It
doesn't eliminate registration, albeit, but margin, capital
requirements, clearing requirements, all that is gone.
What bothers me is looking at the Fed filings, first of
all, five U.S. banks control 95 percent of all the derivatives
trading that is going on. So it is concentrated in five banks.
You look at the filings of these five banks, let's just take
right off the top Goldman Sachs, they have 62 percent of their
derivatives books in foreign affiliates or subsidiaries for
international banking. That is about $134 billion in fair
value.
Let's look at Morgan Stanley. They have 77 percent of their
derivatives book, $101 billion, in non-U.S. operations. So if
you do this, if you say, okay, these--because you have these
foreign subsidiaries, if you do your business through them, you
can do an end-around of all this regulation. That is what you
are doing here. This is a big end-around. This is recklessness.
I understand there is a danger here in uncertainty, and we
would like to, if not harmonize, using Mr. Thompson's term, if
not harmonize, certainly reconcile the regulatory framework
between our country and the countries of Europe and Asia. But
what you are suggesting here is getting rid of--giving a huge
escape hatch for these firms so they don't have to do any of
the things that Dodd-Frank has required to minimize the risk.
And by doing so, you are again planting the seeds for the next
crisis, the next collapse.
This is a return back to the bad old days. That is what is
going on here. Dr. Brummer, tell me I am wrong. Tell me that
this is not what they are trying to do.
Mr. Brummer. Certainly, when you see that most of the
derivatives transactions that are currently--
Mr. Lynch. I am sorry, could you pull your microphone
closer? Thank you.
Mr. Brummer. Certainly when you see that most derivatives
transactions are occurring overseas, this would effectively
exempt those transactions. And I think it is an overstatement
to say that in the absence of Title VII, the protections that
will exist for the U.S. part of the company are going to be
robust. I will say that the G-20 process is slowly grinding
along.
Mr. Lynch. Very slowly, right? Facially they have set a
deadline of 2012, but do you think that is going to happen?
Mr. Brummer. No. It is not going to happen in 2012. And
even with the capital requirements, you see Germany and France
trying to slow down certain parts of Basel III. But my personal
concern is not merely that this encourages a kind of regulatory
arbitrage or opportunity, but the way in which the bill is
drafted, you can go anywhere. You can go to Syria, you can go
to Iran, you can go wherever you want to go, right, set up a
financial center. And if you are a country looking to attract
transactions that are lowly regulated, at least as I interpret
the bill, you can set up that financial center in order to
evade--or to appeal to firms seeking to avoid the protections
that were fought for under Title VII. And I personally don't
understand why one would want that to happen.
I do understand and respect the fact that we want to keep
our financial centers here very strong. But it seems like there
are better ways to go about engaging our international
counterparts.
Mr. Lynch. Thank you. Thank you, Dr. Brummer. I appreciate
that.
Mr. Thompson. Might I have a moment, Chairman Garrett?
Chairman Garrett. I am going to come back to you for that
response if we get through this circle. So hold that thought.
We will now turn to the gentleman from Arizona. But before
we do, I ask unanimous consent to enter into the record some
documents with regard to this issue of intent. They are letters
from Senator Schumer pointing out, as we said in the opening
statement, with regard to their concerns about inconsistencies
with the congressional intent on this matter; a letter from
Senator Johnson and Representative Frank with regard to the
same concern about unintended consequences from the proposed
regulations; a letter from the New Democrat Coalition on this
point; and a letter from the chairman of the Financial Services
Committee, Chairman Bachus, as well. Without objection, it is
so ordered.
Now, to the gentleman from Arizona.
Mr. Schweikert. Thank you, Mr. Chairman. And we are going
to do some bouncing around, so we will get a chance for that.
Mr. Zubrod, help me, just because I want to make sure I am
doing the flow. If this portion of Volcker goes forward, how
different would a transaction look? Do you have to find a flat
in London? What happens here?
Mr. Zubrod. You said ``Volcker,'' I assume you mean the
derivatives?
Mr. Schweikert. The derivatives portion, I am sorry.
Mr. Zubrod. I think, again, it is a matter of cost. If
there is a foreign firm or a foreign subsidiary of a U.S. firm
transacting in Europe, and these requirements have the effect
of limiting the number of counterparties who are effectively
available to bid on a transaction, that is going to impact my
price because I have a smaller, less liquid pool of
counterparties. So I think it ultimately just burdens end-users
with additional and unnecessary costs.
Mr. Schweikert. Thank you, Mr. Zubrod. Do you end up moving
the book of business somewhere else to execute? What do you do?
Mr. Zubrod. No, I don't think so. I think you pay a higher
price.
Mr. Schweikert. Mr. Thompson, same question.
Mr. Thompson. Sure. I think this talk of being able to move
around like you are on a chessboard to evade these requirements
is wildly overstated, the example that Dr. Brummer gave of
Syria. The reality is we are international because that is
where our clients are. That is why we are in London. That is
why we are in Paris. That is why we are in Hong Kong. That is
why we are in Singapore. That is why we are in Tokyo. We are
not going to, and we are not capable of picking up shop and
moving to Syria or Iraq, or some other light-touch regulatory
jurisdiction, because you don't have the facilities there, you
don't have the infrastructure there. In our derivatives trading
businesses, every front office person is supported by seven or
eight back office and support people. You can't find those
people in light-touch jurisdictions. It is simply not possible.
I will also add that the CFTC and the SEC under Title VII
have broad anti-evasion authority to impose Title VII
requirements upon any registrant who structures his business in
a way to avoid the Title VII requirements.
Mr. Schweikert. You hit on something. You are one of the
big shops, correct?
Mr. Thompson. Yes, we are. We are a major dealer in all of
the asset classes.
Mr. Schweikert. Just for a reference point, how many
employees do you have who actually do interest rate hedging
compared to how many employees you have on the regulatory
compliance?
Mr. Thompson. We are seeing--and this trend is increasing,
generally speaking--as I said, the number of front office
people who actually do the business are dwarfed by the number
of support people, the people who process payments, the people
who deal with documents, the people who do regulatory
reporting. And our compliance effort around this is vastly
increasing. We have a whole Title VII implementation
infrastructure in JPMorgan now, and that is between 350 and 400
people.
Mr. Schweikert. So you have 350, 400, and how many interest
rate hedgers?
Mr. Thompson. Our number of front office people, certainly
in New York, where most of them are, is probably 40 to 50.
Mr. Schweikert. Okay. So an interesting ratio there.
Mr. Thompson. Right.
Mr. Schweikert. Just tell us and make sure, because I think
it is worth an expansion because some of the emails and things
that I have gotten keep referring to this as sort of, you are
going to allow AIG to happen again. And I am going to ask you,
Mr. Thompson, because you started, and then I will ask some
solicitation of other people whether they agree or see a hole
in your argument, why won't AIG happen again?
Mr. Thompson. Great. So there are three reasons why AIG
won't happen again under the current regulatory framework. The
first is that, as Congressman Lynch noted, the derivatives
business in the United States is vastly concentrated among five
or six large bank holding companies. All of these entities are
subject to a full and robust system of prudential regulation
globally where the Fed and the OCC have ample oversight
authority on a safety and soundness basis to examine our
foreign branches, subsidiaries, and affiliates. That is a
robust regime. It is ongoing, and it is quite--
Mr. Schweikert. Forgive me, I want to live up to my
chairman's expectation of having only 30 seconds left.
Does anyone on the panel disagree with that as sort of an
explanation? Could I start with Mr. Allen in just the last
couple of seconds that we have? When you see what is coming up,
particularly in the rules being written and we are moving under
Dodd-Frank, do you believe that the regulators are following
the way the statute was intended?
Mr. Allen. No. It is my belief that they are adopting a
very expansive approach to what is written in the statute.
Mr. Schweikert. Thank you.
Dr. Brummer?
Mr. Brummer. All of the examples in Mr. Thompson's
testimony were not prudential, but were disclosure-based, and
so I would disagree with the idea that our system is robust
enough to deal with derivatives transactions.
Mr. Schweikert. Thank you. And I am over my time.
Thank you, Mr. Chairman.
Chairman Garrett. And the gentleman yields back.
And before I yield to the gentleman who just came to the
panel, also without objection, I would like to offer a
statement into the record which was submitted to us by the
Depository Trust & Clearing Corporation--that is the DTTC, of
course--which has written to us with regard to an important
issue dealing with indemnification, which, by the way, I will
just add as an aside, is an issue that the regulators have also
chimed in on. Last week, Congress got a report from the CFTC
and the FTC which stated that a legislative amendment to the
indemnification provision is appropriate. So without objection,
that letter will also be added to the record.
Mr. Hinojosa is recognized for 5 minutes.
Mr. Hinojosa. Thank you, Chairman Garrett. I commend you
for holding today's hearing on limiting the extraterritorial
impact of Title VII of the Dodd-Frank Act. I believe this bill
represents an accomplishment in bipartisanship, and I thank
Chairman Garrett and Congressman Himes for their efforts on
behalf of this legislation.
If there is any financial market that begs for clarity, it
is the derivatives market. These financial tools can be used to
hedge against risk, or, as we have seen in the subprime lending
crisis, they can be used to obscure risk. I believe this market
is now transparent, much more transparent than it has ever
been, thanks to the Dodd-Frank Act and its implementation by
U.S. regulatory agencies.
At this point, U.S. financial firms are asking for clarity
in return from this body and from the regulatory agencies.
While the Dodd-Frank Act sought to ensure the soundness and
transparency of the derivatives markets, its intent was never
to overextend its reach in a way that might harm the
competitiveness of U.S. financial firms on the global stage.
There has been unneeded confusion over the extraterritorial
reach of the regulations set forth regarding swaps markets.
Regulatory agencies should recognize the intent of this body
with regards to Title VII of Dodd-Frank. While I commend the
efforts of the CFTC in implementing this Dodd-Frank Act, I also
would encourage them to limit the scope of their rules to the
United States.
With that, Mr. Chairman, I yield back the remainder of my
time.
Chairman Garrett. Thank you.
The gentleman yields back his time.
Mr. Stivers is now recognized for 5 minutes. Thank you.
Mr. Stivers. Thank you, Mr. Chairman, I appreciate it. And
I appreciate the witnesses' testimony today.
And obviously, we all want to make sure that we don't drive
jobs out of America and we don't make it harder for companies
that need to manage their risk to do so. And I want all of you
to be able to serve your customers wherever they are,
obviously.
So I guess I would like to start by asking a couple of
questions about the big nature of Title VII. Do you think that
Title VII is, as written--if the regulators would implement it
the way it was written by Congress, would cause a problem for--
I will start with Mr. Allen--for firms like yours that are
foreign based, but doing business here in America?
Mr. Allen. I believe the answer is no, not as written by
Congress, and not as we interpret the relevant sections of the
Act, principally Sections 722 and 772. I see those sections as
fundamentally limiting the extraterritorial scope of the Act
subject to, obviously, the well-known caveats from that. Our
concern is that a regulatory approach which takes a different
view and views those provisions as the foundational basis for
an expansive application of regulation is where the problem
starts to arise.
Mr. Stivers. Right. And so you have answered the second
part of the question. Obviously, those regulators have extended
their reach beyond what Congress intended.
What do you think the choices for you will be you, Mr.
Allen, in the long run for Barclays and firms like yourselves
that are foreign based if that extraterritoriality continues
and expands? What will your choice be for jobs in the United
States?
Mr. Allen. It is important to stress that Barclays is very
much in favor of an enhanced and enriched regulatory
marketplace, regulatory-enforced marketplace, but the concern
is where we find ourselves faced with regulations which we
cannot comply with, as a matter of, say, U.S. regulation on the
one hand and European, or specifically U.K., regulation on the
other, but forces us into the position of potentially having to
walk away from that business because, of course, we cannot be
noncompliant with CFTC rules on the one hand, U.K. FSA rules on
the other.
Mr. Stivers. Right. And what does that mean for jobs in
America?
Mr. Allen. It means that we have to look at our U.S.
businesses and consider whether or not we need to try and
insulate that business in some way. The United States is a very
important market for Barclays, and Barclays has no intention of
walking away from that business. It is a core part of our
business.
Mr. Stivers. But it is bad for jobs in America. Is it good
or bad?
Mr. Allen. It makes it more difficult for us to do that
business.
Mr. Stivers. Thank you. I really just wanted it that
simple.
And, Mr. Thompson, you have the other extreme. You are an
American company trying to compete with foreign companies and
trying to follow your customers and clients around the world.
Mr. Thompson. Correct.
Mr. Stivers. Tell me about how extraterritoriality would
complicate American firms, and what it means for your ability
to serve your clients and compete internationally with those
that might not have to have the same regulations.
Mr. Thompson. In the worst case, it severely disadvantages
our overseas business because we would have to apply Title VII
requirements to business with our non-U.S. customers out of our
non-U.S. operations in a way that our competitors would not
have to do so.
It is important to note that this affects not just our
derivatives business, but a lot of our other businesses, such
as investment banking, debt underwriting, and equity
underwriting, also have a symbiotic relationship with our
derivatives business, so being unable to compete with respect
to the derivative has an adverse impact on your entire
investment-banking franchise.
Mr. Stivers. And as your competitiveness, Mr. Thompson,
decreases internationally, what does that do to your profits
of, obviously, an American company that you might be able to
repatriate some of those profits?
Mr. Thompson. Yes. It would be a significant impact to our
revenues. We are a very international firm. It varies from
quarter to quarter, but in some quarters we derive more revenue
from our investment-banking business overseas than we do in the
United States.
I would also point out that it would have a perverse effect
on the ability--and regulators are united on this, and we
believe that by and large it is true--the industry needs to
become better capitalized. Especially in the current
environment for bank equity, the only way for banks to add
capital is through retained earnings. So impairing our ability
to earn significant revenue from our European and Asian and
Latin American franchises will hinder our effort to build our
capital cushion.
Mr. Stivers. Thank you.
So the bottom line for jobs and profits--
Mr. Thompson. Simply phrased, it would be bad.
Mr. Stivers. If the bill is not passed, it is bad. Kind of
simple, getting to the point.
Thank you. I yield back the balance of my time, Mr.
Chairman.
Chairman Garrett. Thank you.
The gentleman yields back, and before I yield back, without
objection, I have three other letters to enter into the record.
Again, these are in support of the underlying legislation,
and also raise the question of the uncertainty under the
proposed rules. They are from SIFMA and ISDA, and the last one
is from the Institute of International Bankers. And the reason
why I left that for last is because I just want to make one
point, and this goes to what Dr. Brummer was saying before.
They raise the point, the fact that this can be satisfied for
those countries that are signatories to the Basel Capital
Accords, which is, in other words, their protection in that
area. And when we have more time, I will probably allow Dr.
Brummer to address that.
But with that, Mr. Carson is recognized for 5 minutes.
Mr. Carson. Thank you, Mr. Chairman.
Thank you, witnesses, for appearing before us.
This question is for Professor Brummer. The CFTC has
indicated that it plans to work on clarifying guidance on this
issue by April. It is not clear whether this will be a formal
regulatory proposal, or if they will utilize a less formal
guidance procedure.
Please give me, Professor, your assessment of the need for
legislative action now versus waiting to review the guidance we
anticipate from the regulators. Do you think more legislative
action now could make the regulators' work more difficult? Or
do you think it will be more timely and even useful in some
instances?
Mr. Brummer. Yes, that question, is in part very difficult,
because it is not just a question of the CFTC, it is also a
question as to what our European counterparts are doing and the
schedule with which they are moving with reforms.
Certainly we are ahead of time, and particularly with
regards to our implementation of something like the Volcker
Rule, that is a question that has to be addressed sooner, quite
frankly, rather than later. But I think that we certainly have
the time for most of the Title VII, as opposed to Title VI
Volcker Rule, to--we have the luxury to see whether or not--see
precisely what the CFTC and their Office of International
Affairs and other folks are doing with regard to accommodating
other regulatory programs in other parts of the world.
Mr. Carson. I yield back. Thank you, Mr. Chairman.
Chairman Garrett. The gentleman yields back.
Mr. Hurt is recognized.
Mr. Hurt. Thank you, Mr. Chairman. Just kind of a general
question, and I, first of all, thank the witnesses, and I
apologize that I wasn't able to hear your statements, but I
have reviewed them. And again, thank you for your appearance.
I come from Virginia's Fifth District, which is a rural
southern Virginia district, and over the years we have--over
the last 10, 20, 30 years, we have been really hit hard by the
loss of our manufacturing sector, textiles and furniture in
particular. As you look at the loss of jobs in our area, one
can't help but be struck by the fact that our inability to
compete in the global marketplace has contributed a lot to the
decline of those sectors. And when you look at the barriers
that we in Washington over the years have put up to make it
more and more difficult for American companies to succeed, I
think that we have to be extremely sensitive to the issue that
we are discussing today.
When you think about the Tax Code, when you think about the
environmental regulations and the labor regulations, all of the
litigation, and the accounting that has to go along with all of
the different regulations, I think that our American companies
have a steep challenge. And I hope that, whether we as a
Congress or the regulators that are implementing our
legislation, it seems to me that it is more important than ever
that we be sensitive to those challenges and those--and,
frankly, those burdens that we put on our American companies.
So, I guess my question would be when you--and this would
be for everyone. I would love to start with Mr. Allen and then
just go down the line. When you look at the importance of
harmonizing our regulatory and legislative structure as it
relates to other countries, can you think of examples that jump
out where we have done that successfully, and can you think of
examples, the worst-case scenario, where we haven't done that
successfully? I would think that certainly manufacturing might
be one of those, but if you could speak just generally to that
topic, because at the end of the day, as my colleague from Ohio
Mr. Stivers said, at the end of the day, this is about jobs for
us.
Mr. Allen. If I may cite an example which actually resides
within Title VII itself, if we think about the position that
Europe is currently heading in regarding the clearing of
derivatives, the proposals there are substantially the same as
those that we see under Title VII. There is a timing question
there, there is a timing delay, that is unquestionably the
case, but there has already been a pretty much arrived-at
political consensus in Europe as to what the shape of that
statute should look like. And it is intended that that statute
be on the statute books by the end of 2012 of this year.
When one looks at the substantive regulation that sits in
that clearing framework, it is very substantially aligned to
what we see in the United States. There are other areas where
that is not the case, admittedly, potentially around execution
through SEFs and things of that nature, as I mentioned before.
But clearing is a good example of where there is a reasonable--
reasonably high prospects of a degree of international
harmonization and convergence around how that is going to work,
which, of course, should not be surprising given that it is
embedded within the G-20 commitments articulated at Pittsburgh.
Mr. Hurt. Thank you.
Mr. Brummer. I would agree.
Mr. Hurt. Mr. Thompson?
Mr. Thompson. There clearly are some areas where
harmonization is working, and I agree that clearing is one of
them, but it is important to note that there are many where
harmonization does not seem to be working. I will give a couple
of examples.
The swaps push-out rule of Section 716, which is a feature
of Title VII, no other jurisdiction of commercial importance
has indicated any interest in adopting it soever.
A second example with respect to the margin rules for
uncleared swaps, the U.S. approach is very proscriptive and
significantly varies from current market practice. The
indications of the approach in Europe will be quite different,
and that you can deal with the risk relating to uncleared swaps
by either capital or margin, but not both, as is in the case in
the United States.
Finally, the approach to the execution mandate on
electronic trading platforms will probably be quite different
in Europe as opposed to the United States.
So it is important to note that although there are some
successes on the harmonization front, there are many areas
where the global regulatory framework will not harmonize.
Mr. Hurt. Thank you.
Mr. Zubrod?
Mr. Zubrod. I would echo some of those comments. In
particular, among the most salient aspects of regulation that
will impact end-users, both financial and nonfinancial, is the
imposition of margin requirements. The U.S. prudential
regulator's rule on margin does impose margin requirements on
all market participants, albeit to varying degrees, depending
on the type of participant. It is not clear that the world will
follow that approach. Indeed, that approach isn't aligned with
congressional intent here in the United States, but even
globally foreign regulators have given signals that they have
questions about the U.S. approach and whether or not capital
requirements are sufficient to address the risks associated
with noncleared swaps. And I think that whether or not
harmonization is possible on that front is a question that will
be answered in time.
Chairman Garrett. The gentleman yields back.
The gentleman who sponsored the legislation is recognized
for 5 minutes.
Mr. Himes. Thank you, Mr. Chairman. Just to start, I would
like to seek unanimous consent to submit two statements for the
record, one from my colleague Gwen Moore, and one from the
ABASA. Thank you.
Chairman Garrett. Without objection, it is so ordered.
Mr. Himes. I guess I would like to explore--I hear two
criticisms of the bill that the chairman and I have written.
One is the whole AIG thing, which I think is faulty, to say the
least, and if I have time, I will come back to that. But I
would also like to explore the concept that this bill would
lead to a race to the bottom. And to do that, I guess I am very
interested in currently.
My understanding is that the vast bulk of the swaps market
occurs within the G-20, and, in fact, specifically trades
largely in New York, London, Hong Kong, Tokyo and Germany. Can
somebody just ballpark for me what percentage of the swaps
market happens in those five jurisdictions?
Mr. Thompson. I will give you my guess. I would say north
of 90 percent, probably closer to 95.
Mr. Himes. Okay. So just for shorthand, let me say that all
of the trading in these instruments happens in those five or
six jurisdictions. If I listen to some of my friends on the
other side, and some of my friends in the banking industry, I
would hear that the efforts that were made to address the
financial meltdown, whether it was Dodd-Frank, or transaction
taxes being discussed in Europe, compensation limits imposed in
the U.K., that we have unleashed the four horsemen of the
apocalypse on the industry. And I wonder, in these last 3 years
in which we have done this, how much of the swaps market has
migrated away from these five or six entities to low
regulation--Dr. Brummer talks about Syria and Iran. How much of
that market, in the face of this assault on the industry, has
migrated away from those jurisdictions?
Mr. Thompson. Certainly at JPMorgan the answer is zero, and
the reason is we are in those jurisdictions because that is
where the clients are, that is where the business is, that is
where the infrastructure is.
As a practical matter, we can't pick up and move to Syria.
Even aside from the anti-evasion authority that the CFTC has
under the statute, we simply can't do it as a practical matter.
Mr. Himes. So my colleague from Massachusetts says that if
we enact this, that effectively we will lift all regulations on
the transactions. Do any of these jurisdictions, London, Hong
Kong, Tokyo, Germany, that effectively are all of the swaps
market--do any of the witnesses want to characterize the
transactional level requirements in those jurisdictions in
which all of these transactions occur? And I am talking about
margin, registration, reporting. Does anybody want to
characterize the regulations in those markets where these
transactions occur as lax?
Yes, Dr. Brummer?
Mr. Brummer. I would certainly not characterize them as
lax, in part because we don't really know what they are. And
they are yet on the books yet, which creates its own problems.
Mr. Himes. But in each of those markets, there are
currently clear regulations subject to evolution.
Mr. Brummer. We have proposals, right. And I would also
want to emphasize, as I said in my report, when you look at the
European Union--and I would agree with Mr. Allen--that there
are some broad levels of consensus. We are different countries
with different histories; we are going to come up with
different approaches. I am not for trying to find a way to
accommodate those differences.
Mr. Himes. But if I could just interrupt you there.
Regulations exist currently in those jurisdictions. It is
probably fair to assume that they will get through Basel III or
through other mechanisms probably more regulatory, probably
fair to assume that. So, again, I just--my question is is the
status quo in any of those jurisdictions currently--can you
characterize the status quo as lax?
Mr. Brummer. I don't think so.
Mr. Himes. Okay. I yield back the balance of my time.
Chairman Garrett. The gentleman yields back, and the
gentleman from California is recognized for 1 minute, and then
we will close since we have votes that were already called.
Mr. Sherman. Thank you.
Mr. Brummer, given the sizable derivative exposures of
foreign branches of some of our major U.S. banks, how can we
ensure that such exposures do not contribute to the systemic
risk here in the United States? And is it typical for the U.S.-
based corporate entity to guarantee or otherwise expose
themselves to the risk of these foreign branches?
Mr. Allen. If I may--
Mr. Sherman. I guess, Dr. Brummer, although--
Mr. Allen. My apologies, of course.
I was just going to say that when it comes to the safety
and soundness regulation which underpins the prudential
approach to the activities of the non-U.S. branches of the U.S.
firms, and this is true internationally as well, they are
subject to considerable regulatory oversight--in the case of
the United States, by the Federal Reserve, and in the case of
the U.K., by the likes of the FSA--which goes to the safety and
soundness of the activities which those institutions undertake.
Much of what we are talking about around Title VII relates
far more to the transactional level-type regulation, where
there is more of a fragmentation in terms of the international
approach to the regulation of those issues, but far less the
case when it comes to fundamental principles of prudential
safety and soundness.
Mr. Brummer. I agree. That is certainly the case. But it is
also useful to understand that many of our prudential
regulations are created with certain expectations as to what
kinds of activities our entities are permitted to do. So
therefore, if you have capital requirements, say, under Reg K
that is not necessarily anticipating foreign banking
organizations from engaging heavily in derivatives and swaps
transactions, and if you also have, say, under Dodd-Frank
provisions that say we are not going to bail out dealers in
derivatives and swaps, then you have to think very hard about
whether or not preexisting capital standards sufficiently
account for the additional risk not only at the entity-level,
but also at the transactional level.
Chairman Garrett. I thank the gentleman for his answers. I
thank the sponsor and all of the members of the subcommittee. I
thank the panel as well.
The Chair notes that some Members may have additional
questions for the panel which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 30 days for Members to submit written questions to these
witnesses and to place their response in the record.
And with that, this hearing is adjourned. Again, thanks to
the panel.
[Whereupon, at 3:43 p.m., the hearing was adjourned.]
A P P E N D I X
February 8, 2012
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