By Katy Burne
As regulators tighten rules on the U.S. swaps market, large
American banks are maneuvering to take some of the business
overseas.
Banks including Bank of America Corp., Citigroup Inc., Goldman
Sachs Group Inc., J.P. Morgan Chase & Co. and Morgan Stanley
are changing the terms of some swap agreements made by their
offshore units so they don't get caught by U.S. regulations,
according to people with knowledge of the situation.
The changes have generally focused on new trades between the
London affiliates of U.S. banks, or between those units and
non-U.S. banks, which combined constitute a large portion of swaps
trading, the people said.
The moves mean the U.S. parent bank is no longer the guarantor
of some swaps issued by its foreign affiliate. Instead, any
liability for those swaps lies solely with the offshore
operation.
Without that tie to the U.S. parent, those contracts won't fall
under U.S. jurisdiction and so won't be subject to new, stricter
rules that include reporting and a requirement that the
historically telephone-traded contracts be traded on U.S.
electronic platforms.
Having swaps come under European oversight is more attractive
because derivatives trading rules on the Continent aren't likely to
be implemented until 2016 at the earliest, allowing the swaps
mostly sold in London to be conducted in relative secrecy. Even
then, some bankers anticipate the European rules won't be as
strict.
While a seemingly arcane shift, the unusual step of removing the
parent guarantees could shift more of the $700 trillion swaps
market to London, Europe's financial hub.
U.S. regulators are aware that banks are making these changes
and so far haven't raised objections, according to the people. The
moves are legal, and some officials have argued that the severing
of guarantees could even help reduce the risk to the U.S. parent
bank should a counterparty to an offshore contract renege on their
agreement, some people said.
The CFTC would become concerned if banks moved a substantial
portion of their swaps business offshore, a more blatant attempt
the skirt the rules, one official said.
Still, detractors say that the U.S. parent bank may still
ultimately choose to bear responsibility for any losses, as some
did during the financial crisis.
The changes could "come back to haunt the American taxpayer,"
said Dennis Kelleher, president of Better Markets, which describes
itself as an advocate for public interest in financial markets. Mr.
Kelleher said he and others had warned lawmakers that banks may
stop guaranteeing swaps sold by their offshore affiliates.
Banks stepped up plans to cut ties with non-U.S. units earlier
this year when the Commodity Futures Trading Commission implemented
U.S. trading rules for swaps. Now, some of the banks are nearly
through the process of working with trading partners to strike the
guarantees of the U.S. parent.
The agreements between large banks are credit-default swaps,
which are used to wager on a borrower's likelihood of repaying its
debts, and interest-rate swaps, often used to hedge against big
swings in borrowing costs.
For U.S. regulators, the new rules aim to bring swaps trading
into the open and protect the U.S. financial system from firms
amassing huge derivatives positions in non-U.S. markets.
The CFTC drafted rules after the 2010 Dodd-Frank law passed to
rein in risky derivatives trading, in part in response to the
massive collection of swaps at American International Group Inc.'s
European unit that led to a $182 billion rescue of the insurer in
2008.
Some warn that the regulators' muted response to the banks'
latest moves may ultimately result in bigger problems.
"Taking away the guarantee removes the legal obligation for a
U.S. entity to bail out trades by a foreign affiliate," said Jack
Chen, principal at derivatives consultancy Pronetik. "But the
regulators are acting on a set of assumptions. There is always the
question of whether or not a bank may be compelled to bail out [an
affiliate] for reputational risks."
Representatives for the Federal Reserve, Office of the
Comptroller of the Currency and Federal Deposit Insurance Corp.
said there was no requirement for the banks to seek their advance
approval or notify the regulators regarding the removal of
guarantees of overseas affiliates.
Marcus Stanley, policy director for Americans for Financial
Reform, a public-interest coalition, warned that if U.S. banks
trade swaps out of unguaranteed affiliates abroad, on platforms
that aren't overseen by the CFTC, they could "avoid Dodd-Frank
rules completely...while trading with other unguaranteed affiliates
of U.S. entities."
Some lawmakers anticipated that banks would seek to shift their
business away from the U.S.
A group of U.S. senators last July warned that the CFTC rules
would "encourage foreign firms to do business with non-guaranteed
foreign affiliates of U.S. firms in return for more favorable
pricing and lighter regulatory scrutiny."
In some cases, it has been hard for banks to persuade their
trading partners to give up the benefits of the guarantees, some
said. In other instances, consents have been easier to obtain
because many swaps are now being processed through central
clearinghouses that guarantee the trades.
"Regulators are demonstrating that they've learned very little
from 2008, when we saw time and again how the biggest banks hadn't
really gotten rid of risk but simply transferred it," said Sen.
Jeff Merkley (D., Ore.).
Andrew Ackerman contributed to this article.
Write to Katy Burne at katy.burne@wsj.com
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