Regulate Thy Neighbour: Competition and Conflict in the Cross-Border Regulatory Space for OTC Derivatives

Abstract

The regulatory overhaul of the global OTC derivatives markets, originating from the G20, is transforming what used to be a relatively harmonised private and transnational legal regime into a public regulatory space fragmented by diverse territorial jurisdictions. In this regulatory space jurisdictional borders are elusive. Especially the United States and the European Union are applying what seems to be a novel type of regulatory strategy designed to protect their market share and curb regulatory arbitrage. The strategy, dubbed here the Regulate Thy Neighbour strategy, builds on unilateralist application of extraterritoriality, forms of direct and indirect protectionism, and conditional deference. Deference strategies such as the US substituted compliance and the EU equivalence regime should be regarded as carrots, applied together with the sticks of extraterritoriality and protectionism to drive regulatory convergence towards the strongest. However, the EU and US have failed to fill the leadership void in the global financial governance system, which remains soft at its core, and instead locked themselves in a regulatory turf war which has prevented them from recognising each other's regulatory frameworks or finalising their own. Meanwhile, looming risks of costly regulatory retaliation are increasing market fragmentation and deglobalisation. The emerging titanic model of systemic risk management, where risk is concentrated in presumably watertight national compartments rather than mutualised globally, is not the way towards a more stable global financial system. In the short term, a successful completion of the transatlantic partnership is needed in order to reach the derivative reform's ultimate goals and to counter financial fragmentation. But acknowledging the many practical and political problems involved in the exportation of rules through the Regulate Thy Neighbour strategy, which can also be manifested in a bilateral form, this paper joins the increasing number of scholars calling for more global and multilateral forms of financial governance.