Getting Ready for Dodd-Frank: A Checklist for Non-Swap Dealers and Non-Major Swap Participants

Checklist: Non-Swap Dealers / Non-MSPs
Getting Ready For Dodd-Frank

WHAT TO DO WHEN

Obtain your LEI / CICI by going to www.ciciutility.org and following applicable instructions

By April 10, 2013                                                   
Report all swaps for which you are the reporting counterparty, as required by Parts 43, 45 and 46 of the CFTC Rules Beginning on April 10, 2013

Maintain all records required by Part 45 of the CFTC Rules

Note: We have assumed that you are already maintaining records required by Part 46 of the CFTC Rules with respect to any "historical swaps".

By April 10, 2013

Adhere to ISDA August 2012 Dodd-Protocol information is available at

http://www2.isda.org/functional-areas/protocol-management/protocol/8 

Note: Adherence may require you to put additional written policies and procedures into place, so as to enable you to give certain representations

By May 1, 2013*

*Sooner is better

For a company that is any of the following:

A non-swap dealer bank or other financial entity; or

An investment manager advising affiliated funds or investment accounts 

Put documentation into place to trade swaps that will be subject to central clearing (e.g., specified CDX and iTraxx credit derivatives, as well standard interest rate derivatives that involve USD, EUR, GBP and JPY)

Note: Most likely "suite" of documents will consist of:

a) Futures customer agreement with futures commission merchant (FCM) and OTC Cleared Addendum ; and

c) OTC Cleared Derivatives Execution Agreement (if you intend to execute away from your FCM)

Also, there is an assumption that you are not an "active fund," since your central clearing requirement would have gone into effect in March 2013.

By June 10, 2013

 

  

Adhere to ISDA Dodd-Frank Protocol 2.0 by going to

http://www2.isda.org/functional-areas/protocol-management/protocol/12 

 

 By July 1, 2013*

*Sooner is better

 

For all others , including, but not limited to, the following:

Energy company;

A "corporate" that uses derivatives for hedging and risk management; 

An ERISA pension plan;

An Investment manager advising unaffiliated or "third party" funds and investment accounts

Put documentation into place to trade swaps that will be subject to central clearing (e.g., specified CDX and iTraxx credit derivatives, as well standard interest rate derivatives that involve USD, EUR, GBP and JPY)

Note: Most likely "suite" of documents will consist of:

a) Futures customer agreement with futures commission merchant (FCM) and OTC Cleared Addendum ; and

c) OTC Cleared Derivatives Execution Agreement (if you intend to execute away from your FCM)

 By September 9, 2013

Take all steps required to claim the end-user exception to central clearing, if applicable to you

Note: If you are an SEC reporting company or your stock is publicly traded, then you may need to obtain approvals from your board of directors.

Also, on April 1st, the CFTC issued its final inter-affiliate clearing exception.  The timeline for this rule has not yet been established, as it is contingent upon publication of the final rule in the Federal Register.  However, you may be required to take actions, if you intend to rely upon that rule.  More information can be found at www.cftc.gov.

 By September 9, 2013

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

The End-User Exception to Central Clearing - Available for Free Download

Attention swap market participants interested in learning more about the end-user exception to central clearing - a free webcast recording from 12/4 is available for download at www.securitiesdocket.com.  

Good day. Good downloading. TSR

The End-User Exception to Central Clearing: A "Walking Map" and Some Introductory Thoughts - NOW IS THE TIME TO FOCUS

 Who Should Pay Attention to the end-user exception to central clearing (and, by extension, this posting)?

You should pay attention to this posting if you are any of the following:

1) A swap dealer or major swap participant that intends to offer hedging products to counterparties;

2) A non-swap dealer bank that intends to offer hedging products to borrowers;

3) A commercial end-user that enters into OTC derivatives as part of your corporate hedging and risk management program, as is the case with many derivatives market participants across many different industries, such as the airlines, steel, transportation, automobile, energy, electricity industries, as well as virtually any other other non-financial industry that you can imagine;

4) A company that "consolidates" or "aggregates" its risk management activity within a single subsidiary that, in turn, enters into hedging transactions with a third-party swap counterparty, such as a swap dealer, major swap participant or non-swap dealer bank;

5) A U.S. publicly traded company, since you will have heightened corporate governance requirements to claim the end-user exception; or

5) A financial institution with $10 billion in total assets, since you may be able to qualify as a "small financial institution" and utilize the end-user exception in connection with your hedging activities.

OK, you convinced us - the topic has broad appeal - what is the end user exception to central clearing?

The end-user exception to Dodd-Frank's central clearing and trade execution mandate is by far one of the most significant aspects of Title VII's derivatives market regulatory reforms. 

In short, the exception will enable a qualifying market participant to implement a risk management and hedging program by entering into non-cleared derivatives - or, in other words, to continue hedging the way that it hedged before the enactment and implementation of Dodd-Frank's reforms.  Due to the nature of this exemption, the list of market participants that will be affected is quite long and covers a broad swath of the derivatives market, ranging from banks offering hedges to borrowers or other customers to publicly traded companies using swaps to hedge or mitigate commercial risk. 

A claimant must either not be a "financial entity" - a technical term defined under the rule and related statutory provision.  Or, in the alternate, the claimant may  be a financial entity that meets one of following exceptions enumerated in CFTC Rule 39.6:

1) Be a "captive finance affiliate";

2) Be acting as an "agent of behalf of its affiliates"; or

3) Be a "small financial institution".

All three of these terms are very technical and are defined under the rule. 

Additionally, a U.S. publicly traded company will be required to take additional corporate governance steps that will, in some manner, involve the approval of the company's Board of Directors or a committee of the Board.

Finally, there are reporting requirements under CFTC Rule 39.6 that apply on a trade-by-trade or annual basis. (And, as an aside, there are also reporting requirements under Parts 45 and 46 of the CFTC's rules that apply in the context of inter-affiliate trades or trades between a non-swap dealer bank, even if those trades qualify for the end-user exception from central clearing.)

Wow - that seems like alot of information to digest.  You did not give us specifics.

We recognize that, but believe that awareness is the first step in the process of understanding and, in our experience, many derivatives market participants are not focused on the importance or complexity of the end-user exception. 

In the coming weeks, we expect that there will be many opportunities for market participants to learn more about the end-user exception.  We will certainly keep you apprised of any such events in which we are participating.

In the meantime, and as an introductory matter, we have created a flowchart or "picture" of CFTC Rule 39.6 that synthesizes this complex rule in one-page. You can download this file by clicking here.

Download file

Consider this a "walking map" to the end user exception - if you would like, call it a "tule" or a TOOL THAT MUST BE READ ALONGSIDE THE RULE (get it, "tule," as in tool for the rule). And, as such, we must give you the standard lawyerly disclaimer that this posting is not legal advice. (And, the Editor-in-Chief gives his thanks to Crystal Travanti for help with thinking through the development of the walking map and Tom Watterson for creating that map.  They are true regulatory cartographers!)

This is a very complex topic that must be analyzed, in light of your particular facts and circumstances, with the assistance of qualified counsel.

Good day. Good luck. TSR

 

Attention Financial Institutions: CFTC Proposes Inter-Affiliate Swap Exemption from Central Clearing Mandate

 

 One of the hallmarks of the derivatives market regulatory reforms under Title VII of the Dodd-Frank Act is the requirement that standardized swaps be subject to central clearing. Yesterday, the Commodity Futures Trading Commission (CFTC) issued a proposal that, if enacted, will afford market participants - including financial institutions - with relief from the central clearing mandate for qualifying inter-affiliate swaps. The proposed rule is available here.

BACKGROUND: THE RELIEF IS LIKELY TO BE MOST USEFUL TO FINANCIAL ENTITIES

As background, there is an "End-User Exception" to the central clearing mandate. That exception, which is found in CFTC Rule 39.6, includes an exemption for inter-affiliate swaps in the context of non-financial end-users. It is not widely available for financial end-users, such as banks, swap dealers, major swap participants, commodity pools. Yesterday's proposal would afford all end-users - including financial end-users - with relief from the central clearing mandate for qualifying inter-affiliate swaps.

AN OVERVIEW OF THE PROPOSED RULE

A swap will be eligible if it was entered into between majority-owned affiliates, such as a parent and a subsidiary or two wholly owned subsidiaries of the same parent corporation, that have consolidated financial statements. Under the proposal, majority ownership will be based upon ownership of a corporation's voting stock or, in the case of a partnership, capital contributions or rights to capital upon dissolution.

Other requirements will also need to be satisfied, including:

1) The affiliates must share a centralized risk management program;

2) The posting of daily variation margin, if the affiliates are "financial entities," a term that includes banks, swap dealers, major swap participants and commodity pools. There is a narrow exception to the variation margin requirements for wholly-owned, commonly-guaranteed affiliates;

3) Board or committee approvals to utilize the exemption, if the party claiming the exemption issues publicly traded securities (i.e., registered under Section 12 of the Securities Exchange Act of 1934 (the "Exchange Act")) or makes public filings under section 15(g) of the Exchange Act; and

4) On-going position reporting to a swap data repository (SDR) and regulatory reporting to the CFTC.

The release also includes information on the availability of the exemption in circumstances where one of the affiliates is located outside of the U.S.

Comments on the proposal are due 30 days after its publication in the Federal Register.

Good day. Good reading and perhaps commenting. TSR

Op-Ed: Systemic Risk is the New Communism (And The Teamsters See It Everywhere)

During a Title VII training session yesterday, I made the following statement: 

systemic risk is the new communism - it seems like everybody is seeing it everywhere.

I have made statement before and - to be honest - every time that I say it, it makes me laugh a little bit more than the last time that I said it. On the one hand, it is a ridiculous statement - and I recognize that. Yet, on the other hand, it is absolutely true - the Dodd-Frank Act could have just as easily been called the "Systemic Risk Management Act of 2010" or even - how about this - "The Hedging of Systemic Risk Act of 2010. " But, I digress...back to the main point...

As I sat down to my morning cup of coffee and stack of "today's" Title VII comment letters on the CFTC / SEC websites, I came across a November 2nd letter from James P. Hoffa, General President of the International Brotherhood of Teamsters, in which the following statement is made:

We [the Teamsters] are deeply concerned by the recent arguments made by financial industry groups that "commercial risks" should be defined to include financial risk where a commercial firm or a bank is hedging financial risk...If the Commission were to interpret the legislation as [the financial] industry groups have suggested, the effect would be that all swaps traded by non-financial entities would be exempt from clearing and trading requirements...

The Teamsters Union, [sic] urges you to reject the arguments made by the financial industry lobby in an attempt to maintain the opaque, unregulated over-the-counter derivatives market. We have seen the catastrophic effects on working families, businesses and the U.S. economy of this market without proper regulation and transparency, and we must not miss this opportunity to bring much needed reform....

Now, I suppose that one response to this letter could be something along the following lines:

"With all due respect, good Sir, that is simply not an accurate statement. Correct - in order to manage systemic risk, Section 2h(1)(A) of the Commodities Exchange Act, as added by Section 723(a)(3) of Dodd-Frank, added a central clearing and trading mandate. Yes, Section 2h(7) contains an exemption from that mandate for swaps that are used to hedge or mitigate commercial risk. BUT, that exemption is called the "end user exemption" because it is only available if the hedging party (or, commercial risk mitigating party, as it were) is not a "financial entity," which Section 2h(7) defines, in pertinent part, as person predominantly engaged in activities that are in the business of banking.

Yes, it is true that one of these financial institutions could enter into a swap with a real, dyed-in-the-wool manufacturer that is using the swap to hedge or mitigate its real, dyed-in-the wool commercial risks and, as a result, the swap be exempt from the clearing mandate - but, that has everything to do with the commercial end-user - even in the hypothetical situation where the financial institution is also using the swap to manage its commercial risk. 

Far from being a threat to "working families, businesses and the U.S. economy," a broad interpretation of "commercial risk" respects the policy objective of the Obama Administration and Congress - regulate in order to manage systemic risk. Why? Because a financial institution using swaps to hedge its financial risks is not the type of activity that creates SUBSTANTIAL systemic risk - which is what the "major swap participant" seeks to manage (say, why isn't it a "Substantial Swap Participant" anyhow?)."

But, I am not going to do that because, well, it seems a little bit over the top. I think that I will just make this observation

SYSTEMIC RISK IS THE NEW COMMUNISM - AND THE TEAMSTERS SEE IT EVERYWHERE.

Communism...Systemic Risk...a letter from the Teamsters...see, even you think it is funnier than when you first heard it.

Good night, good reading.

TSR