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Derivatives experts see another level of regulatory arbitrage taking shape

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Modern Money

Panelists tasked with dissecting the impact of the Dodd-Frank Act at the Futures & Options Expo touched on topics including position limits, margins, swaps dealers and clearing, but the one topic that kept creeping back into the conversation was regulatory arbitrage.

Regulatory arbitrage has long been on the minds of market participants worried that liquidity would shift to countries with the lightest regulatory regime. But as implementation of the Dodd-Frank progresses and U.S. agencies make public their proposed rules, a wrinkle has emerged: domestic regulatory arbitrage.

As Commodity Futures Trading Commission member Scott O’Malia explained, such arbitrage might begin with something as simple as a definition.

“Dealer definition is not always going to be that clear. It certainly isn’t clear today. There are some who are in the dealer definition who I don’t think should be,” O’Malia said. “It will be interesting to see with the new Volcker [rule] out if the CFTC’s definition and the Volcker rule definition and the dealer/trader distinction that the [Securities and Exchange Commission] has used thus far are going to be different and we are going to have a regulatory arbitrage among the regulators.”

In addressing global regulatory arbitrage, O’Malia detailed the CFTC’s effort to coordinate its approach with European regulators. However, Anthony Belchambers, CEO of the Futures and Options Association, said the effort might not be enough to address the global nature of the marketplace.

“When it comes to international integration, I think everyone would agree that we have common policy targets that are shared trans-Atlantically. There are all sorts of positive initiatives that are taking place. It is all very good, except that when it comes to the issue of international standards, jurisdictions tend to cherry-pick what they like and what they don’t like. They don’t adopt it as a block,” Belchambers said. “The second thing is that the Asian countries are looking very carefully at what is going on here, but their attitude is, ‘Why should we follow suit? Isn’t this your problem? It’s not our problem.’ ”

Belchambers said he sees the most room for regulatory discrepancy in margins and the treatment of nonfinancial end users.

Lauren Teigland-Hunt, managing director of Teigland-Hunt, ultimately brought the conversation back to that most basic of principles when discussing regulatory arbitrage.

“We don’t fully know yet how much it is going to cost,” Teigland-Hunt said. “And depending on how much it costs, that has implications for our domestic markets on whether or not they thrive. … If other markets are cheaper and we can’t really control what other markets do and other jurisdictions. You could see overnight a move to foreign markets.”