Transcript Slide 1

Title VII of the Dodd-Frank Act
Regulation
of
Over-the-Counter Derivatives
Objectives of Title VII
• The Objectives of Title VII of the Dodd-Frank Act (the “Act”)
include:
• managing perceived systematic risk in the over-the-counter
(“OTC”) derivatives market; and
• increasing transparency in the OTC derivatives market.
• The Act seeks to achieve its objectives by:
• establishing a regulatory framework for the primary regulators of
the OTC derivatives markets;
• requiring certain OTC derivatives transactions to be cleared and
exchange traded;
• imposing margin and capital requirements on certain OTC
derivatives market participants; and
• requiring OTC derivatives transactions to be reported and certain
information regarding such transactions to be publicly
disseminated.
CFTC and SEC Jurisdiction
• CFTC
• The Act grants the CFTC new regulatory authority over
commodities derivatives and swaps as well as swap dealers,
major swap participants (“MSP” or “MSPs”), swap data
repositories, swap execution facilities for swaps, and clearing
organizations for swaps.
• SEC
• The Act grants the SEC new regulatory authority over securitybased swaps as well as security-based swap dealers, major
security-based swap participants, security-based swap data
repositories, swap execution facilities for security-based swaps,
and clearing agencies for security-based swaps.
Swaps, Security-based Swaps, and
Mixed Swaps
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Swap
• Any agreement, contract, or transaction that: (i) provides for an exchange of payments based upon
the value or level of interest or other rates, currencies, commodities, securities, debt instruments,
indices, quantitative measures, or other financial or economic interests or property of any kind that
transfers financial risk without transferring ownership risk; (ii) is an option on such interests or
property; or (iii) provides for any purchase, sale, payment, or delivery that is dependent upon the
occurrence, non-occurrence or the extent of the occurrence of an event or contingency associated
with a potential financial, economic, or commercial consequence.
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Security-Based Swap
• A swap that is based on a narrow-based security index, a single security or a loan, or the
occurrence, non-occurrence or the extent of the occurrence of an event relating to a single issuer of
a security or the issuers of securities in a narrow-based security index.
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Mixed Swap
• A security-based swap that is also based on the value of one or more interest or other rates,
currencies, commodities, instruments of indebtedness, indices, quantitative measures, other
financial or economic interest or property of any kind (other than a single security or a narrowbased security index), or the occurrence, non-occurrence or the extent of the occurrence of an
event or contingency associated with a potential financial, economic, or commercial consequence.
*For ease of presentation, unless otherwise indicated, references to swap, swap dealer, and major
swap participant also refers to security-based swap, security-based swap dealer, and major
security-based swap participant, respectively.
Newly Regulated OTC Derivatives Market
Participants -- Swap Dealers
• Swap Dealer
• A person who meets any one of the following criteria:
º holds itself out as a dealer in swaps;
º makes a market in swaps;
º regularly enters into swaps with counterparties in the ordinary course of business for its
own account; or
º engaged in any activity causing such person to be commonly known in the trade as a
dealer or market maker in swaps.
• Exceptions
º Does not include a person that enters into swaps for such person’s own account, either
individually or in a fiduciary capacity, but not as a part of a regular business.
º A insured depository institution that enters into a swap with a customer in connection
with a loan that such institution has extended to the customer would not be considered
a “swap dealer” as result of that transaction.
º De minimis exception for entities that engage in a de minimis quantity of swap dealings
in connection with transactions with or on behalf of its customers.
• Status
º The Act authorizes the appropriate regulator to designate a swap dealer for a single,
type, class, or category and not other types, classes, or categories.
Newly Regulated OTC Derivatives Market
Participants -- Major Swap Participants
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Major Swap Participant
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Any person that is not a swap dealer and meets any of the following criteria:
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maintains a substantial position in swaps, excluding (i) positions held for hedging or mitigating
commercial risk and (ii) swaps (but not security-based swaps) maintained by an employee benefit plan
as defined in ERISA for the primary purpose of hedging or mitigating any risk associated with the
operation of the plan;
whose outstanding swaps create substantial counterparty exposure that could have serious adverse
effects on the financial stability of the U.S. banking system or financial markets; or
is a financial entity that is highly leveraged relative to the amount of capital it holds and is not subject
to capital requirements established by an appropriate federal banking agency and also maintains a
substantial potion in outstanding swaps.
Certain captive finance affiliates are excluded from this definition (but not the definition of
major security-based swap participant).
The CFTC and SEC are charged with separately defining “substantial position” and are
authorized to define “commercial risk” .
The Act authorizes the appropriate regulator to designate a MSP for a single, type, class, or
category and not other types, classes, or categories.
Reporting and Recordkeeping
Requirements and Business Conduct
Standards
• Swap dealers and MSPs will be subject to robust reporting and
record keeping requirements, including disclosing transactions,
positions and their financial condition.
• The appropriate regulator is required to adopt business conduct
standards applicable to swap dealers and MSPs.
• Different standards are to be implemented for swap dealers and
MSPs when they are dealing with “Special Entities” such as
governmental entities, pension plans, and endowments.
• Swap dealers and MSPs are required to designate chief compliance
officers.
Clearing Requirements
• General rule
• If the appropriate regulator determines that a swap is required to
be cleared, the parties to such transaction are required to clear
the transaction by submitting it to a derivatives clearing
organization or agency unless a clearing exception is applicable.
• Exceptions
• A swap entered into prior to the enactment of the Act is not
required to be cleared so long as it is reported to a registered
data repository or the appropriate regulator no later than 180
days after the effective date of the Act.
• A swap entered into on or after the date of enactment must be
reported within (i) 90 days after the effective date or (ii) such
other time as the appropriate regulator may prescribe.
• The “commercial end-user” exception is satisfied.
“Commercial End-User”
Exception from Clearing
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The term “commercial end-user” is not defined under the Act. The term generally
refers to those parties opposite a dealer in an OTC derivatives transaction.
The Act contains an optional exception from the clearing requirement for a
counterparty that (i) is NOT a financial entity; (ii) uses the swap to hedge or mitigate
“commercial risk”; and (iii) notifies the appropriate regulator how it meets its financial
obligations associated with entering into non-cleared swaps.
“Financial Entity” means:
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Swap dealer
MSP
Commodity pool
Private fund
ERISA plan
A person predominantly engaged in activities that are in the business of banking or financial
in nature
The CFTC is directed to make a determination whether to exclude banks with less
than $10 billion in assets from the definition of financial entity.
Certain captive finance entities are excluded from the definition of financial entity.
The “commercial end-user” exception is available to publicly-traded companies if the
appropriate committee of the company’s board or governing body reviewed and
approved its decision to enter into non-cleared swap transactions.
Exchange Trading and
Information Disclosure
• The Act requires that all swaps subject to the clearing requirement
be traded on a board of trade designated as a contract market or
securities exchange or through a swap execution facility unless no
such entity accepts the swap for trading.
• A “Swap Execution Facility” is a facility trading system or platform in
which multiple participants have the ability to execute or trade swaps
by accepting bids and offers made by other participants that are
open to multiple participants in the facility or system through any
means of interstate commerce.
• Information on the economic terms and certain other terms will be
required to be reported to swap data repositories or the appropriate
regulator, whether or not the applicable transaction is required to be
cleared or exchange traded.
Capital and Margin Requirements
• The appropriate regulators must establish capital
requirements and, for uncleared swaps, initial and
variation margin on swap dealers and MSPs.
• Derivatives clearing organizations and agencies will
establish margin requirements for cleared swaps.
• The Act does not expressly exempt existing swaps from
margin requirements.
• The Act does not contain an express exemption for
“commercial end-users” from the Act’s margin
requirements.
Section 716 Push-Out Provision
• Subject to a two-year phase in process, swaps
entities receiving “federal assistance” are
required to “push-out” derivatives transactions
prohibited by the Act.
• The prohibition does not apply to derivatives
transactions that (i) are part of a swaps entity’s
hedging or risk mitigating activities or (ii) involve
rates or referenced assets permissible for
investment by a national bank.
Effective Date of Title VII
• Unless otherwise provided, the provisions
of Title VII become effective on a date that
is the later of (i) 360 days following the
enactment of the Act or (ii) if a provision
requires rulemaking, not less than 60 days
after the publication of the applicable final
rule or regulation.
Thank you.
Any questions?