Transcript Financial Executives Networking Group

Key Regulatory Swaps Requirements Under
Dodd-Frank
Presented by:
Julie Kourie
Paul Means
Davis Polk Associates
June 13, 2013
Davis Polk & Wardwell LLP
[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
1
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).
2
Key Elements of Dodd-Frank Derivatives Reform
Clearing and
exchange-style
execution
requirements
Trade reporting and
recordkeeping
Statutory ban on offexchange swaps with
non-ECPs (eligible
contract participants)
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
Extraterritorial
application to crossborder activities
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
3
The OTC Derivatives Market Before Dodd-Frank
Dealer
Counterparty
4
The OTC Derivatives Market Now
Exchange
Margin
and Capital
Dealer
Position Limits
SEC & CFTC
Counterparty
Recordkeeping
and Reporting
Extraterritoriality
Clearinghouse
5
The SEC’s View of the Security-Based Swap Market
6
Regulators
 The Commodity Futures Trading Commission (CFTC) is the agency
responsible for regulating swaps and swap markets. Prior to DoddFrank, 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
CFTC
SEC
Exclusions*
 Puts, calls, options on
securities, indices of
securities, CODs
 Swaps on non-securities:
- Interest rate swaps
- Energy and metal swaps
- Agricultural swaps
- Commodity swaps
 Swaps on broad-based indices
Security-Based Swaps
 Swaps on narrow-based
security indices
“Mixed  Swaps on a single security
or loan
Swaps”
 Swaps on 9 or fewer
securities
 Swaps on government securities
 Cross-currency swaps & NDFs
 Swaptions
 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
*Identified banking products are
but are subject to business
excluded unless bank regulators find
conduct, swap
that they are actually swaps or securitydocumentation, reporting,
based swaps or they are not regulated
and anti-fraud and antiby a bank regulator and are swaps or
manipulation rules
security-based swaps
8
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
9
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 major
security-based swap participants
(SBSDs / MSBSPs)
 end users – commercial or financial
 special entities
10
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
11
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.
13
CFTC Clearing Timeline
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

“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.
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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
15
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.
16
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
19
Business Conduct Requirements
COMPLIANCE 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
20
Business Conduct Requirements
BRIEF 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
a.
Counterparty’s right to clear swaps and select the DCO
b.
Right to receive a scenario analysis
c.
Price and pre-trade mid-market mark of the swap
3. Complying with conduct standards when interacting with the following counterparties
a.
End-Users
b.
Non-ERISA Special Entities (including that it has a qualified independent representative (QIR))
c.
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 March 2013 DF Protocol covers
the following CFTC final rules:
the following CFTC final rules:





External Business Conduct Standards
Rules
 Swap Trading Relationship
Documentation Rules
Real-Time Public Reporting of Swap
Transaction Data
 End-User Exemption to the Clearing
Swap Data Recordkeeping and Reporting
Requirements
 Clearing Requirement Determination
Large Trader Reporting
Requirement for Swaps
896 adhering parties as of May 31, 2013
Swap Dealer Internal Business Conduct
Rules
9,347 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
24
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

Divides Title VII swap dealer requirements into entity-level and transaction-level requirements
U.S. Swap Dealers


Outlines which transactions entered into in a dealing capacity must be counted toward swap
dealer registration
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.
26
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 entitylevel 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?
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212 450 4951 tel
[email protected]
Julie Kourie
ASSOCIATE
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 HIGHLIGHTS
Ms. 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
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
EDUCATION
B.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
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212 450 4728 tel
[email protected]
Paul Means
ASSOCIATE
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
Bar Admissions
 State of New York
 State of New Jersey
 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
Professional History
 Associate, 2011–present
EDUCATION
B.S., Environmental Biology & Management, University of California Davis, 2002
J.D., Brooklyn Law School, 2011
 cum laude
 Richardson Merit Scholar
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