Japan delays cross-border rules amid US and European uncertainty

Japan is delaying its cross-border clearing rules to avoid adding to the “tremendous uncertainty” created by US and Europe over this issue, according to Masamichi Kono, vice-commissioner for international affairs at the Japan Financial Services Agency (JFSA).

The JFSA wants to establish its own set of cross-border rules, and to extend clearing beyond the current interest rate swap and credit default swap remit, but is conscious of inconsistencies in the approaches of global regulators, says Kono (pictured).

“We have been quite careful and reserved in implementing our rules over clearing because we saw a tremendous uncertainty with respect to the issue of consistency across jurisdictions. We don’t even know what the US rules are in their entirety, and in this situation we have refrained from first mandating other products for central clearing, and secondly we have not applied our rules to cross-border transactions – yet.”

He adds: “Normally, our rules should apply to cross-border transactions and to a broader range of standardised products, but up to now we have limited the scope of application in order to seek assurance from our US and European counterparts over any conflicts or inconsistencies.”

On June 15, the European Securities and Markets Authority will provide its advice to the European Commission over whether the central clearing regulatory regime in Japan – and the US – is equivalent to Europe’s. That will ultimately determine if Japanese and US central counterparties (CCPs) can clear any derivatives trade involving European Union counterparties.

Meanwhile, non-US swap dealers, non-US major swap participants and foreign branches of US banks will be required to meet Dodd-Frank requirements once a final exemptive order expires on July 12. Those entities will then be required to meet transaction-level rules, including clearing through a Commodity Futures Trading Commission-registered derivatives clearing organisation (DCO), unless they qualify for substituted compliance – which allows firms to use overseas rules, so long as the CFTC determines they are equivalent to Dodd-Frank. The CFTC has proposed that equivalence test be based on a rule-by-rule assessment of the overseas regime.

The definition of US person could also be extended at the end of the CFTC exemptive order, capturing a large number of offshore funds within the Dodd-Frank rules. Any trade involving a US person must meet Dodd-Frank transaction-level rules, regardless of the location of the transaction.

Kono says Japan is in “intensive discussions with both the US and EC” on these issues, but warned failure to reach agreement could have a disruptive effect on markets.

Japanese regulators have ruled that domestic dealers must clear yen-denominated interest rate swaps via an onshore clearer or a licensed foreign CCP. So far, the Tokyo-based Japanese Securities Clearing Corporation (JSCC) is the only clearer to be granted a licence. That means European entities will be unable to trade yen-denominated interest rate swaps with Japanese dealers if Japan is not recognised as equivalent by European authorities.

Likewise, Japanese dealers will be unable to trade yen swaps with US persons unless the trade clears through a registered DCO. The JSCC has submitted a preliminary application with the CFTC, but it has yet to be approved. Similarly, non-US swap dealers and foreign branches of US banks will be unable to trade with Japanese dealers unless they clear through a DCO, or the CFTC determines the Japanese regime meets the requirements for substituted compliance.

“There is a lot of uncertainty over how the current rules have been applied, and that has of course already caused some firms to decline transactions with US persons, or even potential US persons,” says Kono.

However, he welcomed cross-border proposals by the US Securities and Exchange Commission (SEC), published on May 1. The SEC’s proposals contained a much narrower definition of US person, and based its substituted compliance regime on regulatory outcomes rather than a rule-by-rule assessment.

“The fact the SEC issued such a proposal is welcome, but it does not solve the issues straightaway. Moreover, a large part of the US over-the-counter market is regulated by the CFTC, so we are far from satisfied over the failure to remove uncertainty.”

An in-depth interview with Masamichi Kono will appear in the June issue of Asia Risk.


This article was first published on Risk

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