Davis Polk & Wardwell LLP
Key Regulatory Swaps Requirements Under
Dodd-Frank
Presented by:
Julie KouriePaul MeansDavis Polk Associates
June 13, 2013
[TITLE FOR PRINTING, IF ANY – DELETE THIS, IF NONE]
Agenda
Setting the Stage
Dodd-Frank Act and key elements of U.S. derivatives reform
New swaps terminology
Types of swap counterparties
Overview of Key Swaps Regulatory Requirements
Mandatory clearing requirements
Risk Management rules and requirements, including chief compliance officer requirements
External business conduct standards
CFTC and SEC Proposed Cross-Border Approaches
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The Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed by President Obama on July 21, 2010.
Title VII of the Dodd-Frank Act amended existing law – the Commodity Exchange Act (CEA) and U.S. federal securities laws – to establish a comprehensive new regulatory framework for swaps and security-based swaps (SBS).
Key Elements of Dodd-Frank Derivatives Reform
Clearing and exchange-style
execution requirements
Extraterritorial application to cross-
border activities
Trade reporting and recordkeeping
Margin requirements for uncleared swaps
Position limits and large trade reporting
for physical commodity derivatives
Registration and regulation of swap dealers and major swap participants
Statutory ban on off-exchange swaps with
non-ECPs (eligible contract participants)
Business conduct and documentation standards for swap
dealers and new duties for customers
Risk management, chief compliance officer and other internal duties for
swap dealers
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The OTC Derivatives Market Before Dodd-Frank
Dealer Counterparty
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The OTC Derivatives Market Now
Exchange
Clearinghouse
Dealer CounterpartySEC & CFTC
Margin and Capital
Extraterritoriality
Position Limits
Recordkeepingand Reporting
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The SEC’s View of the Security-Based Swap Market
Regulators
The Commodity Futures Trading Commission (CFTC) is the agency responsible for regulating swaps and swap markets. Prior to Dodd-Frank, the CFTC’s primary role was regulation of the futures markets.
The National Futures Association (NFA) is the self-regulatory organization for the U.S. futures, swaps, and retail FX market participants. NFA membership is mandatory for CFTC registrants.
The Securities and Exchange Commission (SEC) is the agency responsible for regulating security-based swaps and SBS markets. The SEC is the U.S. securities regulator.
The SEC’s SBS rulemaking process is behind the CFTC’s swap rulemaking efforts. Unless noted, this presentation focuses only on swaps rules, as no SBS rules will be effective in the near term.
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Regulatory Status of Products
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“Mixed Swaps”
CFTC SEC
Swaps on non-securities:
- Interest rate swaps
- Energy and metal swaps
- Agricultural swaps
- Commodity swaps
Swaps on broad-based indices
Swaps on government securities
Cross-currency swaps & NDFs
Swaptions
Security-Based Swaps
Swaps on narrow-based security indices
Swaps on a single security or loan
Swaps on 9 or fewer securities
Exclusions* Puts, calls, options on
securities, indices of securities, CODs
Contracts for purchase or sale of securities on a fixed basis or based on contingencies not related to creditworthiness
Commodities contracts and security futures products traded on a contract market
Sale of a nonfinancial commodity for deferred delivery, where physically settled
Limited exclusion for FX forwards and swaps: they are excluded from some swap requirements but are subject to business conduct, swap documentation, reporting, and anti-fraud and anti-manipulation rules
*Identified banking products are excluded unless bank regulators find that they are actually swaps or security-based swaps or they are not regulated by a bank regulator and are swaps or security-based swaps
New Swaps Terminology
The new Dodd-Frank swap regime added many new terms to the U.S. regulatory alphabet soup
swap dealers (SDs)
major swap participants (MSPs)
end users
special entities
It also expanded the scope of existing
regulated market participants:
introducing brokers
futures commission merchants
associated persons
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Types of Swap Counterparties
Swap counterparties will generally fall into one or more of several categories
U.S. persons or non-U.S. persons
swap dealers and major swap participants (SDs / MSPs)
security-based swap dealers and majorsecurity-based swap participants (SBSDs / MSBSPs)
end users – commercial or financial
special entities
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Agenda
Setting the Stage
Dodd-Frank Act and key elements of U.S. derivatives reform
New swaps terminology
Types of swap counterparties
Overview of Key Swaps Regulatory Requirements
Mandatory clearing requirements
Risk Management rules and requirements, including chief compliance officer requirements
External business conduct standards
CFTC and SEC Proposed Cross-Border Approaches
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Swap Clearing Requirements
Swaps that the CFTC determines are required to be cleared must be submitted for clearing to a derivatives clearing organization (DCO). Security-based swaps that the SEC determines are required to be cleared must be submitted for clearing to a clearing agency.
Swaps required to be cleared must be executed on a swap execution facility (SEF) or designated contract market (DCM) once the CFTC has made a determination that such swap is “made available to trade.”
In November 2012, the CFTC designated for mandatory clearing two types of index CDS and several types of interest rate swaps.
The CFTC is expected to make further mandatory clearing determinations covering additional products, potentially including FX options and non-deliverable forwards.
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Swap Clearing Requirements (cont.)
The CFTC’s clearing requirement will be phased in according to the type of market participants that are counterparties to a designated swap.
Commercial End-User Exception: A non-financial entity that is using the swap to hedge or mitigate commercial risk and that elects the exception.
Inter-affiliate Clearing Exemption: Available to “eligible affiliate counterparties” that have a “majority ownership” relationship and that meet other conditions including qualifications for the affiliated counterparties and documentation, risk management and reporting requirements
The SEC has not yet made any clearing determinations with respect to security-based swaps.
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CFTC Clearing Timeline
“Category 1” entities include CFTC-registered swap dealers and MSPs and “active funds.”
“Category 2” entities include commodity pools, private funds (other than active funds) and persons predominantly engaged in banking or financial activities.
“Category 3” entities include ERISA funds, third-party subaccounts and non-financial end-users.
Mandatory Clearing Dates for Designated Swaps
March 11, 2013 for designated swaps between Category 1 entities, other than iTraxx CDS indices
April 26, 2013 for swaps on iTraxx indices between Category 1 entities
June 10, 2013 for designated swaps between Category 2 entities, and between Category 1 and Category 2 entities, other than iTraxx CDS indices
July 25, 2013 for swaps on iTraxx indices between Category 2 entities, and between Category 1 and Category 2 entities
September 9, 2013 for designated swaps involving all other market participants, including those with “third-party subaccounts” (a client account managed by an unaffiliated and independent investment manager that is responsible for the documentation necessary for the account’s owner to clear swaps), other than iTraxx CDS indices
October 23, 2013 for swaps on iTraxx indices involving all other market participants, including those with third-party subaccounts
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Agenda
Setting the Stage
Dodd-Frank Act and key elements of U.S. derivatives reform
New swaps terminology
Types of swap counterparties
Overview of Key Swaps Regulatory Requirements
Mandatory clearing requirements
Risk Management rules and requirements, including chief compliance officer requirements
External business conduct standards
CFTC and SEC Proposed Cross-Border Approaches
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CFTC Risk Management Program for Swap Dealers
Swap dealers must establish risk management systems to:
Monitor and manage enumerated risks
Monitor compliance with position limits
Prevent conflicts of interest relating to clearing and research services
Promote diligent supervision
Maintain business continuity
Maintain disaster recovery programs
Provide for annual audits (risk management program, position limit procedures and the business continuity and disaster recovery plan)
SEC: The SEC has not yet issued final rules on risk management and the designation and duties of the CCO, though the proposed rules are largely similar to the CFTC’s approach.
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CFTC CCO Requirements for Swap Dealers
Swap dealers must designate a chief compliance officer with specified responsibilities:
Administer policies and procedures
Take reasonable steps to “ensure” compliance with applicable statutes and rules “related to swap activities”
Establish procedures to address compliance failures
Resolve “any” conflicts of interest, including by mitigation
Prepare and submit an Annual Report
Review other required reports
Quarterly position limits report; annual risk management program reviews
Annual meeting with Board or Senior Officer
Consultation with Board/Senior Officer
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CFTC Requirements for the CCO Annual Report
The CCO’s Annual Report must:
Describe swap dealer policies and procedures and any material changes
Identify policies reasonably designed to ensure compliance
Assess the effectiveness of policies and procedures
Make recommendations
Discuss areas for improvement
Identify material non-compliance issues and actions taken
Describe resources set aside for compliance, including any material deficiencies
The report must be signed by the CCO, certified by either the CCO or the CEO, and submitted to the CFTC within 90 days of fiscal year-end.
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Agenda
Setting the Stage
Dodd-Frank Act and key elements of U.S. derivatives reform
New swaps terminology
Types of swap counterparties
Overview of Key Swaps Regulatory Requirements
Mandatory clearing requirements
Risk Management rules and requirements, including chief compliance officer requirements
External business conduct standards
CFTC and SEC Proposed Cross-Border Approaches
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Business Conduct RequirementsCOMPLIANCE DATES
CFTC’s external business conduct requirements for swap dealers will be phased in:
May 1, 2013 for most of the external business conduct requirements
July 1, 2013 for portfolio reconciliation and swap trading relationship documentation
The SEC has not yet issued final rules on external business conduct standards
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Business Conduct RequirementsBRIEF DESCRIPTION
The business conduct requirements fall into three general categories:
1.Obtaining information about counterparties
a. Whether the counterparty is an eligible contract participant
b. Other know-your-counterparty information, including its clearing status
2.Disclosing information to counterparties
§ Counterparty’s right to clear swaps and select the DCO
§ Right to receive a scenario analysis
§ Price and pre-trade mid-market mark of the swap
3.Complying with conduct standards when interacting with the following counterparties
1. End-Users
2. Non-ERISA Special Entities (including that it has a qualified independent representative (QIR))
3. ERISA Special Entities (including that it has a fiduciary)
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Business Conduct Requirements ISDA PROTOCOLS
ISDA has developed two Protocols to address the CFTC’s external business conduct rules and other new Title VII requirements.
A Protocol is a multilateral contractual amendment mechanism that allows for standardized amendments to be made to the swap agreements between adhering parties
DF Protocols can be used to amend all existing swap agreements that govern swaps between a swap dealer and its customers – not just ISDA Master Agreements.
DF Protocols provide an option for counterparties if they have not previously executed an ISDA or other trading agreement.
DF Protocols also enable swap dealers to provide disclosures to, and receive representations from, counterparties.
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Business Conduct Requirements ISDA PROTOCOLS (cont.)
The August 2012 DF Protocol covers the following CFTC final rules:
External Business Conduct Standards Rules
Real-Time Public Reporting of Swap Transaction Data
Swap Data Recordkeeping and Reporting Requirements
Large Trader Reporting
Swap Dealer Internal Business Conduct Rules
9,347 adhering parties as of May 31, 2013
The March 2013 DF Protocol covers the following CFTC final rules:
Swap Trading Relationship Documentation Rules
End-User Exemption to the Clearing Requirement for Swaps
Clearing Requirement Determination
896 adhering parties as of May 31, 2013
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Agenda
Setting the Stage
Dodd-Frank Act and key elements of U.S. derivatives reform
New swaps terminology
Types of swap counterparties
Overview of Key Swaps Regulatory Requirements
Mandatory clearing requirements
Risk Management rules and requirements, including chief compliance officer requirements
External business conduct standards
CFTC and SEC Proposed Cross-Border Approaches
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CFTC Proposed Cross-Border Guidance
The CFTC’s proposed cross-border guidance
Provides a definition of “U.S. person” for purposes of the CFTC’s Title VII swap regulations
Outlines which transactions entered into in a dealing capacity must be counted toward swap dealer registration
Divides Title VII swap dealer requirements into entity-level and transaction-level requirements
U.S. Swap Dealers
Must comply with all transaction-level and entity-level requirements.
Non-U.S. Swap Dealers
Entity-level requirements apply However, substituted compliance with home country requirements could be available where the
CFTC has made a comparability determination.
Transaction-level requirements Apply to transactions with a U.S. person
Apply to transactions with a non-U.S. person guaranteed by a U.S. person, unless substituted compliance is available
Do not apply to other transactions between a non-U.S. swap dealer and non-U.S. person
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CFTC Temporary Exemptive Order
The temporary exemptive order will expire on July 12, 2013 (pending further CFTC action).
It provides a temporary / interim definition of U.S. person.
It delays compliance with entity-level requirements for non-U.S. swap dealers, except SDR/trade reporting and large trader reporting.
It allows non-U.S. swap dealers and foreign branches of U.S. swap dealers to delay compliance with transaction-level requirements for swaps with non-U.S. persons and other foreign branches.
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SEC Proposed Cross-Border Rules
The SEC’s proposed cross-border rules divide Title VII security-based swap requirements into dealer- and major participant-specific entity-level and transaction-level requirements, and proposed to separately address those requirements applicable to market participants generally.
U.S. Security-Based Swap Dealers: Must comply with all transaction-level and entity-level requirements; however, there are certain exceptions for U.S. banks conducting “foreign business” through “foreign branches.”
Foreign Security-Based Swap Dealers:
Entity-level requirements apply. However, substituted compliance with home country requirements could be available where the SEC
has made a comparability determination.
Transaction-level requirements: External business conduct requirements would apply to “U.S. business” but not to “foreign
business.”
Segregation requirements apply in a more complex manner based on whether the entity is also an SEC-registered broker-dealer, whether the entity is a foreign bank with a U.S. branch and whether a particular counterparty is a U.S. person.
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Compliance Challenges for Cross-Border Transactions
U.S. Person Definition: The CFTC has proposed one definition in the proposed interpretive guidance, has proposed alternatives for certain prongs of that definition in the further proposed guidance, and is currently using an interim definition, as outlined in the final exemptive order. The SEC has proposed a definition that differs from all of the CFTC’s definitions, and is also different from the SEC’s existing U.S. Person definition under Regulation S.
Entity-Level and Transaction-Level Requirement Classification: The CFTC and SEC have proposed to classify the Title VII requirements applicable to swaps and security-based swaps differently. For example, the CFTC has classified margin requirements as transaction-level, while the SEC has proposed to classify margin requirements as entity-level. This means that:
A non-U.S. branch of a U.S. non-bank registered as a swap dealer and as a security-based swap dealer must comply with CFTC and SEC margin requirements with respect to transactions with non-U.S. persons, and is eligible for substituted compliance for these transactions under the CFTC approach, but not under the SEC’s approach.
A non-U.S. non-bank security-based swap dealer must comply with SEC margin requirements for all counterparties, and is eligible for substituted compliance. The same non-U.S. non-bank swap dealer must comply with CFTC margin requirements only with respect to U.S. counterparties (assuming its non-U.S. counterparties are not guaranteed by U.S. persons and are not non-U.S. affiliate conduits), but is not eligible for substituted compliance for these transactions.
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Questions?
Julie KourieASSOCIATE
Ms. Kourie is an associate in Davis Polk’s Financial Institutions Group. She advises financial institutions, corporations and industry groups on the requirements, impact and implementation of the Dodd-Frank financial reform legislation, particularly the regulatory treatment, trading and clearing of swaps. Since joining the firm in 2011, she has completed a rotation in the Credit Group.
WORK HIGHLIGHTSMs. Kourie has been actively involved in Dodd-Frank Act analysis and advice, including:
Frequent advice to clients on the impact and implementation of Dodd-Frank, particularly related to swaps
Analysis of Dodd-Frank rulemaking progress through the Davis Polk Regulatory Hub
Drafting and submitting comment letters on various proposed swap and security-based swap regulatory rules
Assisting a major financial institution in drafting its resolution plan
EDUCATIONB.Bus.Sc., Law, University of Cape Town, 2004 Distinction in Law UCT Dean's Merit List Twamley Scholarship
LL.B., University of Cape Town, 2006 magna cum laude
LL.M., New York University School of Law, 2011 Vogelstein Scholar Arthur T. Vanderbilt Scholarship UCT/NYU Exchange Scholarship
212 450 4951 [email protected]
Bar Admissions
State of New York
Professional History
Associate, 2011–present
Associate, Environmental Law, DLA Cliffe Dekker Hofmeyr, 2009–2010
Articled Clerk, DLA Cliffe Dekker Hofmeyr, 2007–2009
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Paul MeansASSOCIATE
Mr. Means is an associate in Davis Polk’s Financial Institutions Group. He advises financial institutions, corporations and industry groups on the requirements, impact and implementation of the Dodd-Frank financial reform legislation, particularly with respect to the regulatory treatment, trading and clearing of derivatives under Title VII.
As a member of the core team that manages the Davis Polk Regulatory Hub, Mr. Means has worked closely with major financial institutions to help them employ new technology and to develop and refine implementation and compliance plans for Title VII requirements.
WORK HIGHLIGHTS
Mr. Means has been actively involved in Dodd-Frank Act analysis and advice, including:
Frequent advice to clients on the impact and implementation of Dodd-Frank, particularly as it relates to swaps and security-based swaps
Management of the Davis Polk Regulatory Hub, an online subscription service providing analysis of regulations under Title VII and the Volcker Rule through exportable requirements and tasks addressing these new regulatory obligations
Assistance to swap dealers regarding the CFTC registration process, development and implementation of compliance plans, including in the context of cross-border derivatives transactions, and preparation and drafting of their CCO Annual Reports
EDUCATION
B.S., Environmental Biology & Management, University of California Davis, 2002
J.D., Brooklyn Law School, 2011 cum laude Richardson Merit Scholar
212 450 4728 [email protected]
Bar Admissions
State of New York
State of New Jersey
Professional History
Associate, 2011–present
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