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May 20, 2011

Ben Bernanke, Chairman

Board of Governors of the Federal Reserve System

John Walsh, Acting Comptroller

Office of the Comptroller of the Currency

Sheila Bair, Chairman

Federal Deposit Insurance Corporation

John Bowman, Acting Director

Office of Thrift Supervision

Dear Federal Regulators of the Financial Institutions of the United States:

Americans for Financial Reform (AFR) strongly disagrees with the recent letter from members of the New York Congressional delegation calling for a blanket exemption from U.S. derivatives regulations for foreign subsidiaries of U.S. banks when dealing in foreign jurisdictions. By prioritizing arguments about global competitiveness above concerns about the safety and soundness of U.S. financial institutions, it encourages a return to the regulatory race to the bottom that so recently devastated our financial markets.

AFR is an unprecedented coalition of over 250 national, state and local groups who have come together to reform the financial industry. Members of our coalition include consumer, civil rights, investor, retiree, community, labor, religious and business groups as well as prominent economists

As the letter itself points out, the Dodd-Frank Act explicitly instructs regulators to impose margin and other financial stability requirements in all cases where there is a “direct and significant” connection to U.S. economic activity. The activities of foreign subsidiaries of U.S. banks certainly meet this test, as losses in a foreign subsidiary could threaten the financial stability of the U.S. parent company and by extension the stability of the U.S. financial system.  Exempting foreign subsidiaries of U.S. banks from U.S. derivatives regulations could lead to a repetition of risky, unmargined and unregulated derivatives dealing by U.S. banks. The fact that this dealing would take place in foreign “havens” from regulation would not avert the potential consequences to the U.S. banking system in the event of serious losses.

The new Dodd-Frank regulations already permit banks to forego margin in almost all cases when dealing with end users hedging commercial risk. Thus, the exemption called for in this letter would apply to affiliates of U.S. banks dealing with foreign financial institutions and foreign speculators. It is no doubt true that in some cases such entities would prefer not to back their speculative derivatives exposures with collateral. However, it is entirely appropriate that prudential regulators would wish to safeguard U.S. bank holding companies from exposure to such risks, including through their foreign affiliates.

The letter correctly highlights the importance of coordination and harmonization of world derivatives regimes. Regulators are currently working on such harmonization. The EMIR process in Europe, the G-20 communique on financial regulation, and the various efforts in key Asian markets are all proceeding in the same general direction – toward central clearing, some form of exchange trading, and margin requirements. The blanket exemption proposed in this letter would actually undermine this process of harmonization by creating a powerful incentive for a country to set itself up as a haven from international regulation, where subsidiaries of U.S. banks could locate and remain free from prudential regulation. Geographical exemptions from regulation fuel such “race to the bottom” outcomes and weaken incentives to coordinate around a sound regulatory regime. They also draw business away from well-regulated financial centers such as the United States and toward foreign locations willing to permit lax regulation.

The U.S. financial sector has gained its international reputation due to our global leadership in creating stable and transparent markets. Indeed, it was over 150 years ago that the U.S. pioneered the derivatives clearinghouse. This was a major positive innovation in establishing robust and valuable marketplaces for commodities as well as key financial markets. The US economy will benefit from having transparent, sound and reliable capital markets, and global industry will participate in our capital markets to the extent that they are transparent, sound and reliable. Although permitting regulatory loopholes may create short-term profits, in the long run the greatest threat to the U.S. competitive edge is a repetition of the deregulation that led to the disastrous financial crisis of 2008.

Sincerely,

Americans for Financial Reform

cc:

Senator Kristen Gillibrand

Senator Charles Schumer