The Commodity Futures Trading Commission (CFTC) has unveiled a proposal to supervise and regulate derivative trades by U.S. financial institutions abroad. As per the provisions of the Dodd-Frank Act, the CFTC was required to frame rules to enhance transparency and restrict risky trades in over-the-counter swaps market.
The new proposal by the CFTC requires increased oversight of derivative transactions that take place overseas. The proposal will also extend to foreign banks that have significant derivative trading operations in the U.S. However, if the home country of the foreign banks also has almost similar rules then they would be exempted from complying with the new proposals.
To comply with the new rules, foreign banks will have 12 months time after the publication of the proposal while U.S. banks have time till January 2013. Further, the foreign banks are required to register with the National Futures Association (NFA) to get the advantages of delayed compliance. Also, it will be necessary for these banks to submit a compliance plan for meeting the U.S. or foreign swaps regulations.
The CFTC proposal guidance has set up two kinds of rules – Entity-Level Requirements and Transaction-Level Requirements. Entity-Level rule will manage capital, data record-keeping and internal business conduct standards. Transaction-Level regulations will oversee how trades are guaranteed by central clearinghouses, margin, trade execution and sales practices.
The proposed guidelines are available for public comments for 45 days, while public comments on delays can be put forward till July 29.
In wake of the huge marked-to-market trading loss at JPMorgan Chase & Co. (JPM) and the collapse of the Lehman Brother Inc. as well as the near-collapse of American International Group Inc. (AIG) in 2008 primarily due failed overseas derivative strategies, we believe that the new regulations governing the financial institutions for derivative transactions is a need of the hour.
However, derivative transactions (mostly overseas) are a major source of revenue for many of the U.S. banks that include JPMorgan and The Goldman Sachs Group Inc. (GS). Hence, these banks are likely to face depressed revenue and higher compliance cost, once the proposal is passed.
Nevertheless, the rules are still in the proposal phase. These might lead to the development of regulations that address concerns of all. In fact, we believe that eventually, such regulations would be able to prevent substantial trading losses and other negative implications from the same.
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