NEW YORK, N.Y. – Peter Beyers and Stanley Sellers, two former Wall-Street derivative’s traders, are leading a group of financial professionals in a quest to create a derivatives trading system completely untethered from financial regulation. The idea is to establish human and technological infrastructure robust enough to support a legitimate presence in the derivatives market that operates apart from any regulatory scheme. “Navigating the do’s and don’ts of the new and existing regulation across the world is becoming increasingly difficult and burdensome for market participants,” said Mr. Beyers. “Imagine the efficiencies you could create by cutting away all the red tape.”
But finding a way to stay out of reach of regulation while still maintaining a presence in derivatives markets creates a unique challenge. “The regulatory landscape in today’s world is changing,” Beyers explained. “All of the major markets exist in geographies that have either implemented, or are developing regulatory frameworks governing derivatives. We found that we couldn’t think laterally in terms of location, we had to think vertically.”
So Beyers and Sellers formulated a plan, which they call Perpetual Extraterritorial Trading, or PET. The idea is to retrofit Cold War Era B-52 bombers with computing and wireless connectivity technology to create mobile trading desks. These aircraft would be kept in the air 24 hours a day, 365 days a year, circling in international airspace, thereby operating outside the jurisdiction of any existing regulatory body.
The idea for Perpetual Extraterritorial Trading, referred to unofficially by those involved as Operation Dodge-Frank, came from an unlikely source. Sellers explains, “Peter and I were talking favorite films. We got on the subject of Dr. Strangelove, where the US maintains a fleet of continuously airborne B-52 bombers never more than 2 hours from their Soviet targets. All of a sudden a light-bulb went off: rather than racing to the jurisdiction with the least constrictive regulation, why not put the swap desks where there is no jurisdiction?” And with that, Perpetual Extraterritorial Trading was born.
Financial markets have seen a considerable uptick in regulation following the economic crisis of 2008. The two largest bodies of legislation came in the form of Dodd-Frank in 2010 for the US and EMIR in 2012 for European markets. Other markets, including various Asian countries and Canada, are nearing completion of regulatory overhauls of their own. Beyers and Sellers admit that they recognize the positive role oversight plays in avoiding a repeat of 2008, but they worry that new legislation is often unclear, unfair, and at times, overreaching. While their goal may be total escape from regulation, they point to a few issues in particular as animating motivation behind PET:
Margin requirements. The G-20 met in 2011 to harmonize a globalized approach to margin requirements for derivatives. Following this meeting, the Basel/IOSCO led Working Group on Margining Requirements (WGMR) created an agreement finalized in September 2013 that regulators in many jurisdictions are beginning to implement to varying degrees. However, inconsistency across, and even within, jurisdictions is a cause for concern for many market participants, especially multi-national entities. For example, the WGMR proposed, and the EU tentatively affirmed, that margin requirements would not apply to Non-Financial Entities. The US, however, has been reluctant to offer this same comfort. In fact, while the CFTC embraced this approach and proposed to exempt end users from margin requirements, the Federal Reserve and the other bank regulators have taken a different position and proposed imposing margin requirements on end users when exposures exceed bank-set thresholds. And although European end users will likely be exempt from margin requirements under EU regulations, EU regulators have proposed applying margin requirements to trades between non-EU end users and EU banks. Ongoing crystallization of legislative and regulatory processes could lead to further clarity along any of these lines, but there is still more than enough uncertainty surrounding the issue of margin to keep end users on their toes.
Extraterritoriality. In July 2013, the CFTC added footnote 513 to its cross-border guidance, indicating that swap transactions originated by non-US Swap Dealers would be subject to US swaps rules if they involved US staff in the transaction. This was not welcomed by swap dealers, who consequently found themselves subject to Dodd-Frank and foreign regulation simultaneously. Despite the US determination, uncertainty clouds the future of cross-border derivatives regulation. The US and EU continue to negotiate cross-border regulatory approaches, with the EU looking to resolve concerns about the expansive reach of US law via a transatlantic trade agreement. Meanwhile, banks have sued, charging that the CFTC’s cross-border approach did not go through proper channels. Thus, companies transacting across borders are left sorting through parallel rules, and often needing to comply with the rules of multiple jurisdictions, at least for the time being.
These are just two of the many issues created by a world-wide ramping up of regulatory reform that the creators of Operation Dodge-Frank are looking to avoid. While they may be ambitious, the two men are not blind to the project’s shortcomings. On the challenge of sourcing and maintaining his aerial fleet, Beyers admits; “It’s a logistical nightmare.” Airworthy B-52s are relatively scarce and finding one for sale has proven near impossible. On the other hand, while Beyers originally feared he would not be able to staff his project, he was ultimately surprised: “It was far easier than I anticipated to find financial professionals willing to work long hours away from home under highly stressful conditions. Who knew?”
Perhaps more importantly, the two men acknowledge a fundamental flaw in the PET system: “You can remove yourself from every regulation under the sun,” Sellers explained. “But as long as your counterparty is subject to regulation, you can never truly escape the reach and ramifications.” His solution? “We hope to encourage others to follow suit. We envision a world where airborne armadas of PET entities transact with each other in a truly regulation-free environment. That is the purity of essence that we are striving for.”
When asked about their biggest fear moving forward with Dodge-Frank, the two men answered candidly; “Crash and burn,” Beyers said. “What we are doing has never been done, and it is not without risk. Quite literally, this could all go down in flames if the hardware malfunctions. But there’s also the figurative crash and burn. Insulating yourself from rules that are fundamentally designed to protect markets is a dangerous move. What we’re doing is not for the faint of heart, we have no illusions about that. Some people say we’re nuts; we’re not saying they’re wrong.”
Beyers and Sellers estimate the roll-out date for Perpetual Extraterritorial Trading under the most optimistic circumstances to be no sooner than July of 2016. “We have our work cut out for us and a lot will have changed between now and then, but we are confident that the market for our service will only continue to grow. After all, the sky’s the limit,” said Beyers. “Our best advice,” he continued, “is that rather than waiting for the tide of regulation to turn in your favor or looking for ways to avoid regulation, make sure you have a strong expert and advocate like Chatham in your corner to help you comply and prepare for what is coming down the pipeline. The better you understand the requirements, the better prepared you will be to adapt in an ever-changing market place.”
“And if anyone out there has a B-52 for sale,” Sellers added, “please let us know.”
If you would like to discuss how current and future regulatory requirements may affect you and your hedging strategy, give us a call at 610.925.3120 or email us.