The Swap Report : Derivatives Lawyers & Attorneys: Reed Smith Law Firm: Investment & Commodity Laws

June 10th marks the day on which many "Category 2 Entities" will be required to centrally clear certain credit default index and interest rate swaps.  Unlike the Category 1 implementation date - which only involved swap dealers with the operational infrastructure required to process cleared swaps -  the June 10th implementation date will affect thousands upon thousands of market participants with varying degrees of operational capabilities and limitations.  The affected participants will include non-swap dealer banks that use interest rate swaps to manage the risks of routine commercial lending activity, as well as the vast majority of mutual funds and hedge funds that trade the types of swaps to which the clearing mandate applies. 

At the present time, we are receiving a relatively unprecedented number of inquiries as to whether or not the June 10th implementation date applies to a particular type of market participant or swap and, if so, what effects the June 10th implementation will have on business and investment operations. 

By way of example, we continue to receive inquiries as to the types of swaps that will be subject to the June 10th clearing mandate. In other cases, market participants understand the scope of the central clearing mandate, but are hurriedly putting clearing and execution documentation into place, so that they can run operational testing to ensure that trading processes will function as intended on June 10th.  We also continue to receive calls on a daily basis from clients who have not yet started to negotiate clearing and execution documentation.  We have no way of knowing how many trading relationships "remain to be papered," but expect that it is not an immaterial segment of the Category 2 universe of market participants. 

Finally, we have spoken with several market participants who have documentation in place and have already conducted their operational testing, but are deeply concerned that June 10th will cause disruptions in the trading of the contracts that are subject to central clearing due to the sheer volume of market participants that will be affected on June 10th. 

Together, this mix of information does not seem to point to a Category 2 implementation that will be as seamless as the Category 1 implementation in March 2013. 

Accordingly, we believe that now is the time to defer the June 10th Category 2 implementation date.  Having said that, we also believe that Category 2 market participants that are ready to clear should start doing so as soon as possible.  In short, we believe that both regulators and market participants have a responsibility to do what they can to avoid a "mad rush to clearing," and the potential adverse consequences that could result if many market participants are, in fact, not ready for central clearing on June 10th.

Good day.  Good time for a delay. TSR

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By David Surbeck, Reed Smith LLP

In the attached piece, David Surbeck of Reed Smith LLP offers practical insights about the documentation of eligible contract participant (ECP) provisions in the context of single bank loan and syndicated agent lending transactions. 

You may access this article by clicking the following link:

Download file

This article makes reference to recent provisions published by the Loan Syndications & Trading Association ("LSTA") and the International Swaps and Derivatives Association ("ISDA").   

You can access the LSTA provisions, along with a memorandum (dated 15 February 2013) that the LSTA published in respect of these provisions, by clicking here.

You can access the ISDA provisions by going to www.isda.org and searching for "ISDA Keepwell" in the Search box (that is usually located in the upper right hand corner of the screen).  There are two related pieces: 1) the provisions themselves; and 2) a brief memorandum published by ISDA explaining these provisions.  ISDA published this material on April 18, 2013.

Good day.  Good, practical insights. TSR

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The proposed agenda covers:

• Minimum Block Sizes for Swaps;
• The "Made Available to Trade" Rule Under section 2(h)(8) of the Commodity Exchange Act and Swap Transaction Compliance and Implementation Schedule;
• Core Principles for Swap Execution Facilities (SEFs); and
• Anti-disruptive Practices Authority - Interpretive Guidance and Policy Statement.

You can obtain information about participation by clicking here.

Good day. Good agenda. TSR

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 By Andrew Cross, Crystal Travanti and Tom Watterson of Reed Smith LLP

We have prepared the above-referenced guide to the eligible contract participant ("ECP") definition under section 1a(18) of the Commodity Exchange Act ("CEA").  The guide does not cover every aspect of the ECP definition, but rather focuses on the application of the so-called "entity" and "natural person" ECP tests as:

1) Presented in section 1a(18) of the CEA;

2) Implemented by CFTC Rule 1.3(m); and

3) Interpreted and augmented by CFTC Letter 12-17.

It is our hope that this guide clarifies the key aspects of the ECP definition.  Of course, the guide does not constitute legal advice, since any application of the ECP definition must give effect to the unique situations of the counterparties and their swap transaction.

Download file

Good day.  Good guide? TSR

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We are asked this question with ever increasing frequency, so we thought that we would answer it "once and for all".

These are the forms that the question takes:

How do I know if my counterparty is a swap dealer?

How do I know if I am trading with a foreign affiliate of a U.S. swap dealer?

Are there any major swap participants registered with the CFTC right now?

Do you know if there is an "official" list of registered swap dealers and major swap participants?

And, the answers to those questions can be found by clicking the link under each heading below.

Swap Dealers 

Click here for the CFTC's official list of provisionally registered swap dealers (current as of the date listed at that website).

Major Swap Participants

Click here for the CFTC's official list of provisionally registered major swap participants (current as of the date listed at that website)

And, that may result in another question:

What does it mean for a swap dealer or major swap participant to be "provisionally registered"?

It means that the National Futures Association has received a Form 7-R from the SD or MSP.  

Given the "in-progress" status of implementation of the Dodd-Frank Act's changes to the Commodity Exchange Act and related CFTC rules, the entire industry is provisionally registered as of this particular point in time. 

That will change at some point in the future - don't ask when, because we do not know either. 

Good day.  Great questions. TSR

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By Todd Zerega and Tom Watterson

On April 19th, The Treasury Market Practice Group (“TMPG”) of the New York Fed proposed to revise its guidance to market participants, the Best Practices for Treasury, Agency Debt, and Agency Mortgage-Backed Securities Markets (the “Best Practices”) to support more timely trade confirmations in the tri-party repo market (the “Proposal”). The TMPG publishes the Best Practices to serve as operational guidelines and for participants in the tri-party repo markets, based upon existing market conduct.

The Proposal would revise the Best Practices to ensure that all market participants would execute and confirm all tri-party repo trades by 3:00 p.m. (Eastern Time). Of the noteworthy changes, the Proposal includes that all tri-party repo trades executed before 3:00 p.m. should be matched and confirmed by 3:00 p.m., and that all tri-party repo trades executed after 3:00 p.m. should be matched and confirmed within 15 minutes.

The Proposal can be found here.

The TMPG is requesting public comments on the Proposal. Comments are due by May 17th, 2013, and can be sent to tmpg@ny.frb.org.

Good day. Good Practices. TSR
 

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By Todd Zerega and Tom Watterson 

The Federal Reserve Bank of NY released their monthly statistics of the U.S. tri-party repo market for February and March.

For the month ending February 11, 2013, the total collateral in the U.S. tri-party repo market decreased by $21 billion, a decrease of 1.1%. The total collateral in the U.S. tri-party repo market decreased by another $19 billion, or 1%, for the month ending March 11, 2013 resulting in $1.83 trillion in collateral overall. While the amount of collateral decreased for most asset classes, agency debentures and Strips increased in both February and March by 13.6% and 6.4% respectively. In February, the amount of US Treasuries, excluding Strips, held as collateral fell by $32 billion, a decrease of 5%.

Haircuts remained relatively stable with the median haircut remaining constant during February and March.

The statistics for February are available here and for March are available here

Good day. Good reading. TSR   

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By Andrew Cross and Crystal Travanti

OVERVIEW

The CFTC recently issued no-action relief from certain swap data reporting requirements for swaps entered into between affiliated counterparties.  The relief is conditioned upon several factors, which we have summarized in greater detail in the table below. 

In general, Letter 13-09 grants relief from: historical swap reporting (Part 46); "regular" swap reporting under Part 45 for swaps entered into on or after April 10, 2013; and reporting requirements under the end-user exception (Part 50).  The following is a list of the specific regulatory reporting requirements for which Letter 13-09 grants relief:

• CFTC Rule 45.3(d)(1) - Primary economic terms data reporting
• CFTC Rule 45.3(d)(3) - Confirmation data reporting
• CFTC Rule 45.4(c)(1)(ii) - Life cycle event and state data reporting
• CFTC Rule 45.4(c)(2)(ii) - Current daily mark valuation reporting
• CFTC Rule 45.5 - Unique swap identifier requirements
• CFTC Rule 46.3(a) - Reporting of historical swaps in existence on or after 4/25/2011
• CFTC Rule 46.3(b) - Reporting of historical swaps expired or terminated prior to 4/25/2011

• CFTC Rule 50.50 - Reporting of swaps for which end-user exception central clearing has been claimed

Additionally, it is important to note that the no-action relief granted for swaps that involve wholly-owned subsidiaries differs from the relief granted for swaps that involve majority-owned subsidiaries. 

Under Letter 13-09, the relief is available where the affiliation arises by virtue of either:

1) A parent-subsidiary relationship between the affiliates; or
2) A brother-sister relationship (i.e., common parent relationship) between the affiliates. 

In either case, the affiliation can be direct or indirect. Finally, the relief granted in Letter 13-09 does not apply to any swaps for which the affiliated counterparties have elected to claim the inter-affiliate exemption from central clearing pursuant to CFTC Rule 50.52.

SUMMARY OF RELIEF GRANTED UNDER LETTER 13-09: PART 45, PART 46 & PART 50 

In this section of the posting, we will provide a more detailed summary of the specific relief granted under Letter 13-09.  To facilitate a "snapshot view" of that letter, we have prepared a table that summarizes the conditions of the relief in respect of the Part 45 and Part 50 reporting requirements listed above - we address Part 46 in the final paragraph that immediately follows the table.

Finally, with respect to Part 46, the CFTC clarified that a reporting counterparty must satisfy the conditions summarized in the first four rows of the table.  Furthermore, any such reporting counterparty must adhere to the recordkeeping requirements of the Part 46 rules.

Good day.  Good relief. TSR

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By Andrew Cross and Tom Watterson, Reed Smith LLP

INTRODUCTION

The CFTC just released (less than 7 hours before the deadline) CFTC Letter No. 13-10 providing no action relief from the reporting requirements of Parts 43, 45, and 46 for non-swap dealer, non-major swap participant counterparties. By our count, there are now nine different reporting deadlines.

As an introductory item, non-swap dealer banks or other financial entities that have reporting obligations (such as hedge funds or insurance companies) should all be aware that the swap reporting requirements for new interest rate swaps and credit swaps begins April 10, 2013.

AN OVERVIEW OF LETTER 13-10

The extent and timing of the relief provided by CFTC Letter 13-10 is a function of several factors:

•  The classification of the counterparty as a financial entity (as defined under Section 2(h)(7)(C)(i)  of the Commodity Exchange Act) 

• The asset class of the swap - foreign exchange*, interest rate, credit, equity  and other commodity - that is subject to the reporting requirement

• The particular type of reporting obligation (Part 43 real time reporting, Part 45 "regular" reporting, Part 46 historical swap reporting)

• The "new" compliance date

* CFTC Letter No. 13-10 uses the term "foreign exchange swaps" (which is a defined term in §1a(25) of the CEA) as one of the asset classes. We assume that this is referring to all "foreign exchange transactions" that fall under the reporting requirements, inclusivie of foreign exchange swaps and foreign exchange forwards that have been excluded from the definition of a "swap" pursuant to the determination by the Secretary of the Treasury. The final rule release for Part 45 uses the term "foreign exchange transactions."

There were also, of course, certain policy reasons offered in support of the relief.  So, put another way, CFTC  Letter 13-10 can be thought of as consisting of answers to the following questions:

Who is the reporting counterparty?

What type of swap is being reported?

Where in the CFTC's rulebook can the particular reporting obligation be found?

When do the reporting obligations become effective under the deferred compliance schedule?

Why was the relief issued?

To help you make sense of it all, we have developed the following - "The Who, What, Where, When and Why" Table for CFTC Letter 13-10.

And, what is the WHY?

The CFTC staff acknowledged that the development of swap data reporting systems has encountered more technological and operational challenges than expected and that reporting compliance has been more difficult for equity swaps, FX swaps, and other commodity swaps. However, the CFTC staff claimed that financial entities (such as non-swap dealer banks) were more likely to have pre-existing technological capability to develop swap reporting systems.

NO RELIEF FROM RECORDKEEPING REQUIREMENTS

CFTC Letter 13-10 did not afford any relief from the recordkeeping requirements under Parts 43, 45 or 46 of the CFTC rules.

And, as a practical item, since Part 45 recordkeeping obligations begin April 10, 2013, non-swap dealer, non-major swap participant counterparties must obtain a CFTC Interim Compliance Identifier by April 10, 2013 (they can do so by going to www.ciciutility.org). 

 AND, FINALLY, WHO IS A FINANCIAL ENTITY?

A "financial entity" has the meaning given to it in Section 2(h)(7)(C)(i) of the Commodity Exchange Act.  By way of non-limiting example, that statutory definition certainly covers banks, insurance companies and hedge funds.  So, it is very clear...for some market participants. 

But, what about a subsidiary of a commercial holding company that manages risk on behalf of the entire commercial, non-financial enterprise by entering into hedging transactions with other non-swap dealers, as well as non-swap dealers? Is that type of "risk management subsidiary" a financial entity or not?  Is its risk management an activity that is "financial in nature under section 4(k) of the Bank Holding Company Act"? How should that type of a risk management subsidiary apply the deadlines in CFTC Letter 13-10?

That question was not addressed by the relief in CFTC Letter 13-10, which can be found here.

Good day. Good delay(s)? TSR

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Please note that this message does not constitute legal advice and, in any event, may not be applicable to your particular situation.  Therefore, you should consult with legal counsel to determine whether: 1)  any of the enumerated items are applicable to you; or 2) if you need to take any additional actions not enumerated on the above list.

Good day.  Good luck. TSR

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A few updates of note:

1) Dodd-Frank Protocol 2.0 Open - As of March 22nd, Dodd-Frank Protocol 2.0 is open for adherence.  More information is available here.

2) Further Guidance Issued by TMPG on Initiative to Margin Forward Agency MBS - On March 27th, the Treasury Market Practices Group of the New York Fed issued additional guidance on its initiative to various delayed delivery trading of agency mortgage-backed securities.  Of note, the TMPG delayed its recommended compliance schedule from early June to year end 2013.  There are also clarifications as to:

a) the type of MBS trading subject to margining (TBAs, ARMs, specified pools, and CMOs); and

b) the forward period that will subject a trade to margining (greater than 3 days for CMOs and greater than 1 day for TBAs, ARMs and specified pools.

The guidance is available here. 

Also, you can read our original article on the TMPG's recommendation here.

3) Swap Reporting - As of now, the swap reporting rules go into effect on April 10th (as if you all did not know).  Although, it is widely expected that there will soon be a barrage of well-reasoned requests from nearly every corner of the market for delays.  We believe that this delay is needed, especially for non-swap dealer market participants, and entirely consistent with existing deferral patterns for other aspects of Title VII implementation.  But, only time will tell.

Good day.  Good endurance. TSR

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 By Todd Zerega and Tom Watterson

The Federal Reserve Bank of NY released their monthly statistics of the U.S. tri-party repo market.

For the month ending January 10, 2013, the total collateral in the U.S. tri-party repo market decreased by $94 billion, a decrease of 4.8%, to $1.88 trillion. The amount of collateral decreased for almost every asset class, with agency MBS leading the decline and decreasing by $54 billion, or 7%.　 The share of the total tri-party repo collateral that was agency MBS fell by 0.9%. The only asset groups where the amount of collateral held in tri-party repos increased were private label CMOs, by $16 billion or 15.4%, and ABS, by $0.22 billion or 0.6%.

Haircuts remained relatively stable with the median haircut remaining constant for all collateral types except for money market instruments, which fell from 5% to 3%.

The statistics are available here.

Good day.  Good statistics. TSR

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By Todd Zerega and Andrew Cross

Under the "Bucket Theory," Zero Purchase Price Repo Transactions Are Considered "Repurchase Agreements" Under Section 101(47) of the Bankruptcy Code by Todd Zerega and Luke Sizemore

In re Homebanc Mortgage Corp.,
No. 07-51740-KJC, 2013 WL 211180 (Bankr. D. Del. Jan. 18, 2013)

CASE SNAPSHOT

The Bankruptcy Court found that individual repurchase transactions having a purchase price of zero may fall within the definition of "repurchase agreement" under section 101(47) of the Bankruptcy Code provided that the master agreement governing such transactions acknowledges that each transaction constitutes consideration for every other transaction under the master agreement.

FACTUAL BACKGROUND

In 2005, the debtor entered into a master repurchase agreement and a global master repurchase agreement (together, the "Master Agreements" and each, a "Master Agreement") with a counterparty.  The Master Agreements governed the parties' relationship at the macro level, and specific transactions made pursuant to the Master Agreements were documented on the micro level with written confirmations.  The Master Agreements contained acknowledgments that all transactions entered into pursuant to each Master Agreement constituted a single business transaction.  The Master Agreements provided further that any payments, deliveries, and other transfers made by either of the parties in respect of any transaction shall be deemed to have been made in consideration of payments, deliveries and other transfers in respect of any other transactions entered into under the Master Agreement.

Between June 2006 and August 2007, the debtor and its counterparty entered into numerous repurchase transactions under the Master Agreements.  The written confirmations for certain of these transactions showed a purchase price of zero.  After the debtor failed to pay the aggregate repurchase price on the date due, the counterparty issued formal notices of default on August 9, 2007.  The debtor filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code later that evening.  Following the bankruptcy filing and the imposition of the automatic stay, the counterparty liquidated the securities subject to the Master Agreements by auction, and used the auction proceeds to set off against the debtor's unpaid repurchase amounts.

COURT ANALYSIS

Section 101(47) of the Bankruptcy Code defines "repurchase agreement" to mean:

an agreement . . . which provides for the transfer of one or more . . . mortgage related securities . . . against the transfer of funds by the transferee of such . . . securities . . ., with a simultaneous agreement by such transferee to transfer to the transferor thereof . . . securities . . . at a date certain not later than 1 year after such transfer or on demand, against the transfer of funds.

11 U.S.C. § 101(47) (emphasis added).  Under the safe harbor or section 559 of the Bankruptcy Code, non-debtor counterparties to a "repurchase agreement" may avoid the prohibitions of the automatic stay and undertake acts to collect, recover, or set off pre-petition debts without court approval.

The debtor argued that the transactions at issue could not be "repurchase agreements" because the corresponding confirmations noted a zero purchase price, meaning that the securities were not transferred to the counterparty "against the transfer of funds."  The debtor believed that, as a result, the counterparty's post-petition exercise of its contractual remedies was not protected by the safe harbor of section 559.  The counterparty disputed the debtor's analysis by relying upon the acknowledgment contained in the Master Agreements that each transaction under the Master Agreements constituted consideration for every other transaction.  Under this "bucket theory," the counterparty claimed that any transaction under the Master Agreements with a purchase price greater than zero provided sufficient consideration to satisfy the "transfer of funds" requirement with respect to the zero purchase price securities at issue.

The Court agreed with the counterparty, explaining that the acknowledgments in the Master Agreements apply to each transaction regardless of the purchase price listed on the confirmations.  In other words, the acknowledgments must be read as the backdrop for each transaction.  There is no need for the parties to restate the acknowledgments in every individual confirmation for that transaction to qualify as a repurchase agreement.  Because the zero purchase price transaction constituted "repurchase agreements" under the Bankruptcy Code, the Court held that such transactions were entitled to the benefits provided to repurchase agreements under the safe harbor of section 559.

PRACTICAL CONSIDERATIONS

When determining whether a particular transaction falls within the definition of "repurchase agreement" under the Bankruptcy Code and is entitled to the safe harbor protections of section  559, the transaction cannot be judged in isolation but, rather, must be analyzed collectively with the corresponding master agreement and its affiliated transactions.  There may be certain attributes of the master agreement and affiliated transactions that bring an otherwise non-repo transaction within the meaning of "repurchase agreement" under the Bankruptcy Code.

Good day.  Good consideration(s) [puns intended all the way around]. TSR

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Section 2(e) of the Commodity Exchange Act requires every swap counterparty to be an eligible contract participant ("ECP").  In CFTC OGC Letter No. 12-17, the CFTC Office of General Counsel stated that it interprets section 2(e) to require each guarantor of a swap to be an ECP.  In other words, as a general rule, a non-ECP can not guarantee the obligations of a swap counterparty that is an ECP.

This interpretive position should be noted by all banks that offer interest rate swaps to borrowers as hedges, regardless of whether or not the bank is a swap dealer.  And, for obvious reasons, it is also of interest to borrowers.

Inspired by the recent Valentine's Day holiday, we offer our readers the following summary:

In these days post-Dodd-Frank,
It can be hard to be a bank.

Or even a borrower, friends you see,
With a swap that is guaranteed,
By someone other than an ECP.

Good day.  Good poem? TSR

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