Journal of Business & Technology Law Volume 14 | Issue 2 Article 2 Too Big to Fail — U.S. Banks’ Regulatory Alchemy: Converting an Obscure Agency Footnote into an “At Will” Nullification of Dodd-Frank’s Regulation of the Multi-Trillion Dollar Financial Swaps Market Michael Greenberger Follow this and additional works at: https://digitalcommons.law.umaryland.edu/jbtl Recommended Citation Michael Greenberger, Too Big to Fail — U.S. Banks’ Regulatory Alchemy: Converting an Obscure Agency Footnote into an “At Will” Nullification of Dodd-Frank’s Regulation of the Multi-Trillion Dollar Financial Swaps Market, 14 J. Bus. & Tech. L. 197 () Available at: https://digitalcommons.law.umaryland.edu/jbtl/vol14/iss2/2 This Article is brought to you for free and open access by the Academic Journals at DigitalCommons@UM Carey Law. It has been accepted for inclusion in Journal of Business & Technology Law by an authorized editor of DigitalCommons@UM Carey Law. For more information, please contact [email protected]. Too Big to Fail—U.S. Banks’ Regulatory Alchemy: Converting an Obscure Agency Footnote into an “At Will” Nullification of Dodd-Frank’s Regulation of the Multi-Trillion Dollar Financial Swaps Market MICHAEL GREENBERGER*©1 ΎLaw School Professor, University of Maryland Carey School of Law, and Founder and Director, University of Maryland Center for Health and Homeland Security (“CHHS”); former Director, Division of Trading and Markets, U.S. Commodity Futures Trading Commission. The Institute for New Economic Thinking (“INET”) funded and published this article as a working paper on the Social Sciences Research Network on June 19, 2018 at https://www.ineteconomics.org/uploads/papers/WP_74.pdf. The paper was presented that day at a meeting of interested scholars at INET in New York City. The video of that gathering can be found at https://www.youtube.com/watch?v=xT-tie8sFog. Former Federal Reserve Chairman Paul Volcker and former Federal Deposit Insurance Corporation Vice Chairman Thomas H. Hoenig were both present at the meeting and supported the paper’s findings. Professor Greenberger was also separately interviewed about the paper by INET President Rob Johnson on June 19, 2018. That interview can be found at https://www.ineteconomics.org/perspectives/videos/another-financial-cri sis-could-be-coming. The paper and accompanying presentation received considerable subsequent media attention: See, e.g., Emily Flitter, Decade After Crisis, a $600 Trillion Market Remains Murky to Regulators, N.Y. TIMES (Jul. 22, 2018), https://www.nytimes.com/2018/07/22/business/ derivatives-banks-regulation-dodd-frank.html; The Dodd-Frank Loop- hole, Creating Black Images, Government Approved Trolling, WNYC RADIO (August 16, 2018), https://www.wnyc.org/story/ midday-on-wnyc- 2018-08-16 (radio interview by Jenna Flanagan with Michael Journal of Business & Technology Law 197 Too Big to Fail ABSTRACT The multi-trillion-dollar market for, what was at that time wholly unregulated, over-the-counter derivatives (“swaps”) is widely viewed as a principal cause of the 2008 worldwide financial meltdown. The Dodd-Frank Act, signed into law on July 21, 2010, was expressly considered by Congress to be a remedy for this troublesome deregulatory problem. The legislation required the swaps market to comply with a host of business conduct and anti-competitive protections, including that the swaps market be fully transparent to U.S. financial regulators, collateralized, and capitalized. The Greenberger discussing the loophole in Dodd-Frank); Zephyr Teachout & Morris Pearl, Voters Can Help Avoid Another Costly Bail Out, TIMESUNION (August 11, 2018), https://www.timesunion.com/opinion/ article/Voters-can-help-avoid-another-costly-bail-out-13149693.php (agreeing that a loophole exists in Dodd-Frank with “foreign” swaps dealers); Marcus Baram, Big banks are exploiting a risky Dodd-Frank loophole that could cause a repeat of 2008, FAST COMPANY (June 29, 2018), https://www.fastcompany.com/90178556/big-banks-are-exploiting-a- risky-dodd-frank-loophole-that-could-cause-a-repeat-of-2008 (interview with Michael Greenberger); Jim Zarroli, Big Banks Are Once Again Taking Risks With Complex Financial Trades, Report Says, NPR (June 19, 2018), https://www.npr.org/2018/06/19/621543525/big-banks-are-o nce-again-taking-risks-with-complex-financial-trades-report-says (citing Michael Greenberger’s paper); Claire Boston, Swap Loophole Leaves U.S. Taxpayers on Hook for Trades, BLOOMBERG (June 19, 2018), https://www.bloomberg.com/news/articles/2018-06-19/swap-loophole- leaves-u-s-taxpayers-on-hook-for-trades-report; Pam Martens & Russ Martens, Wall Street’s Derivatives Nightmare: New York Times Does a Shallow Dive, WALL STREET ON PARADE (July 24, 2018), http://wallstreetonparade.com/2018/07/wall-streets-derivatives-night mare-new-york-times-does-a-shallow-dive (citing the Flitter article). This article was completed on April 30, 2019. Since that time, national and international banking regulations and institutions may have gone through further change. © Michael Greenberger, 2019. ϭ 198 Journal of Business & Technology Law MICHAEL GREENBERGER statute also expressly provides that it would cover foreign subsidiaries of big U.S. financial institutions if their swaps trading could adversely impact the U.S. economy or represent the use of extraterritorial trades as an attempt to “evade” Dodd-Frank. In July 2013, the CFTC promulgated an 80-page, triple-columned, and single-spaced “guidance” implementing Dodd-Frank’s extraterritorial reach, i.e., that manner in which Dodd-Frank would apply to swaps transactions executed outside the United States. The key point of that guidance was that swaps trading within the “guaranteed” foreign subsidiaries of U.S. bank holding company swaps dealers were subject to all of Dodd-Frank’s swaps regulations wherever in the world those subsidiaries’ swaps were executed. At that time, the standardized industry swaps agreement contemplated that, inter alia, U.S. bank holding company swaps dealers’ foreign subsidiaries would be “guaranteed” by their corporate parent, as was true since 1992. In August 2013, without notifying the CFTC, the principal U.S. bank holding company swaps dealer trade association privately circulated to its members standard contractual language that would, for the first time, “deguarantee” their foreign subsidiaries. By relying only on the obscure footnote 563 of the CFTC guidance’s 662 footnotes, the trade association assured its swaps dealer members that the newly deguaranteed foreign subsidiaries could (if they so chose) no longer be subject to Dodd-Frank. As a result, it has been reported (and it also has been understood by many experts within the swaps industry) that a substantial portion of the U.S. swaps market has shifted from the large U.S. bank holding companies swaps dealers and their U.S. affiliates to their newly deguaranteed “foreign” subsidiaries, with the attendant claim by these huge big U.S. bank swaps dealers that Dodd-Frank swaps Journal of Business & Technology Law 199 Too Big to Fail regulation would not apply to these transactions. The CFTC also soon discovered that these huge U.S. bank holding company swaps dealers were “arranging, negotiating, and executing” (“ANE”) these swaps in the United States with U.S. bank personnel and, only after execution in the U.S., were these swaps formally “assigned” to the U.S. banks’ newly “deguaranteed” foreign subsidiaries with the accompanying claim that these swaps, even though executed in the U.S., were not covered by Dodd-Frank. In October 2016, the CFTC proposed a rule that would have closed the “deguarantee” and “ANE” loopholes completely. However, because it usually takes at least a year to finalize a “proposed” rule, this proposed rule closing the loopholes in question was not finalized prior to the inauguration of President Trump. All indications are that it will never be finalized during a Trump Administration. Thus, in the shadow of the recent tenth anniversary of the Lehman failure, there is an understanding among many market regulators and swaps trading experts that large portions of the swaps market have moved from U.S. bank holding company swaps dealers and their U.S. affiliates to their newly deguaranteed foreign affiliates where Dodd- Frank swaps regulation is not being followed. However, what has not moved abroad is the very real obligation of the lender of last resort to rescue these U.S. swaps dealer bank holding companies if they fail because of poorly regulated swaps in their deguaranteed foreign subsidiaries, i.e., the U.S. taxpayer. While relief is unlikely to be forthcoming from the Trump Administration or the Republican-controlled Senate, some other means will have to be found to avert another multi-trillion-dollar bank bailout and/or a financial calamity caused by poorly regulated swaps on the books of big U.S. banks. This paper notes that the relevant statutory framework affords state attorneys general and state financial 200 Journal of Business & Technology Law MICHAEL GREENBERGER regulators the right to bring so-called “parens patriae” actions in federal district court to enforce, inter alia, Dodd- Frank on behalf of a state’s citizens. That kind of litigation to enforce the statute’s extraterritorial provisions is now badly needed. TABLE OF CONTENTS I. SUMMARY AND INTRODUCTION ........................................................... 205 II. THE TROUBLED HISTORY OF THE SWAPS MARKET AND ITS POOR REGULATION ..................................................................................................