CFTC Targets Swaps Loophole

WASHINGTON—U.S. swaps regulators sought to close a legal loophole that allowed American banks to shift some of their business overseas to avoid tough U.S. rules.

The Commodity Futures Trading Commission on Monday voted 4-0 to propose tighter restrictions on certain swaps booked by overseas branches of U.S. firms, requiring the offshore units adhere to CFTC rules even in cases where the units' American parents aren't explicitly on the hook for the trades.

The rules aim to eliminate the risk of a repeat of the financial crisis when risky bets placed by American International Group Inc.'s offshore unit nearly destroyed its U.S. parent. They also target concerns among regulators and some lawmakers that banks are shifting business overseas to avoid U.S. requirements. Banks including Bank of America Corp. and Citigroup Inc. have stopped guaranteeing some swaps issued by foreign affiliates, primarily in London, eliminating ties to their U.S. parent.

Under the CFTC's approach, even "de-guaranteed" transactions, as they are known, would be forced to comply with U.S. rules if the offshore units' results are consolidated in the financial statements of the parent firm.

"Risk created offshore can flow back into the U.S.," CFTC Chairman Timothy Massad said in a written statement. "The proposal draws a line as to when we should take this offshore risk into account that is both reasonable and clear."

CFTC officials said the plan primarily affects the largest U.S. banks, which consolidate their offshore units into their parent firms' financial statements. U.S. accounting rules generally require consolidation of entities in which the parent has a "controlling financial interest."

The CFTC would have to collect comments on the proposal and vote on it a second time before it would go into effect.

Monday's proposal, which Mr. Massad previewed in a speech in early June, is an add to a related proposal the agency floated last year that applies to a relatively small pocket of the multi-trillion swaps market that isn't backed by central clearinghouses. Clearinghouses are entities designed to help prevent a market-wide collapse by ensuring either party in a derivatives transaction would get paid if the other side falters.

The rules would set collateral known as margin on trades between an overseas swaps dealer and another firm.

Swaps—contracts in which two parties agree to exchange payments based on fluctuations in interest rates or other benchmarks—were targeted by U.S. lawmakers for greater oversight and transparency after they played a central role in the financial crisis. Companies use the swaps market to hedge risks or make bets in areas such as fuel prices or interest rates.

Banks have tried to circumvent the CFTC's rules by shifting swaps trading to overseas affiliates, primarily those in London, that are no longer guaranteed by their U.S. parent or that have revoked guarantees on specific transactions. Those moves, while legal, have stoked concerns from regulators over whether a U.S. bank's foreign losses could ultimately find their way to U.S. shores, potentially destabilizing the parent firm.

Mr. Massad's approach could generate criticism from banks and their trade groups, which have said the current practices benefit the U.S. because they shift potentially risky trading overseas. The International Swaps and Derivatives Association, which represents large banks involved in the swaps market, said it was studying the proposal.

J. Christopher Giancarlo, the lone Republican member of the CFTC, called Monday's proposal is a "highly complicated labyrinth." His support for floating the proposal for comment "should not signal...my agreement with it," he said in a written statement.

Write to Andrew Ackerman at [e-mail]

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