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Dodd Frank Update: Impact on
Gas & Power Transactions
10th Annual Gas and Power Institute
September 22-23, 2011
Craig R. Enochs
Craig R. Enochs
[email protected]
Jackson Walker L.L.P.
1401 McKinney, Suite 1900
Houston, Texas 77010
(713) 752-4315 phone
General Overview
• Who does the Dodd-Frank Act affect?
• What should you be doing now to get
ready for compliance?
• Reading the tea leaves: where will we
end up?
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I. Who Does Dodd-Frank Affect?
•
Primarily:
– Major Swap Participants
– Swap Dealers
•
But also End Users that use Swaps:
– What is a Swap?
– Who is an End User?
– What do End Users have to do under the Act?
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I. Who Does Dodd-Frank Affect?
What is a “Swap?”
– § 721(a)(21): Includes commodity swaps and energy swaps.
• Forward contracts generally are not “Swaps”.
– Proposed by the CFTC:
• Physical commodity options
• Any transaction willfully structured to evade Title VII requirements.
• See CFTC Proposed Rules: Further Definition of “Swap” (76 Fed.
Reg. 29,818) (May 23, 2011).
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I. Who Does Dodd-Frank Affect?
Who is an End User?
• The term “End User” is used throughout Title VII, in
the Congressional record and in the Dodd-Lincoln
Letter, but it is not explicitly defined in the Act.
• CFTC proposed rulemakings give guidance, but no
final rulemaking has been issued.
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I. Who Does Dodd-Frank Affect?
Who is an End User?
• In the context of CFTC clearing requirements, an “End User” is:
• A non-Financial Entity
• Using Swaps to hedge or mitigate its commercial risks
• CFTC Proposed Rule on End-User Exception to Mandatory
Clearing of Swaps (75 Fed. Reg. 80,747) (12/23/2010).
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I. Who Does Dodd-Frank Affect?
Who is an End User?
– “Financial Entity”:
• Laundry list of parties stated in § 723(a)(3).
• Expressly includes Major Swap Participant and Swap Dealer.
– Thus, a “non-Financial Entity” cannot be either an MSP or SD.
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I. Who Does Dodd-Frank Affect?
Who is an End User?
– Uses Swaps to hedge or mitigate commercial risk:
• Qualify as “bona fide hedges” under CEA rules;
• Qualify for treatment under FASB Statement No. 133; or
• Swaps are “economically appropriate for the reduction of risks in the
conduct and management of a commercial enterprise”.
– CFTC Proposed Rule on End-User Exception to Mandatory
Clearing of Swaps (75 Fed. Reg. 80,747) (12/23/2010).
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I. Who Does Dodd-Frank Affect?
Who is an End User?
– Dodd-Lincoln Letter: Letter from Senators Dodd and Lincoln to
Representatives Frank and Peterson dated June 30, 2010:
• “End Users should not be treated as Swap Dealers simply
because they regularly use Swaps to hedge risk.”
• The term “End User” should include any End User of the
commodity being hedged, including energy producers, power
retailers, airlines and those financing routine business
activities.
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I. Who Does Dodd-Frank Affect?
Who is an End User?
– Many industries have lobbied to Congress.
• Who will win?
• Airlines, brewers, farmers, utilities, etc.
– Probably will include most entities we think should be End Users.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– “Nothing” is incorrect
– The Act still applies to End Users:
• Pre-enactment and transition swap reporting (§ 723)
• Opt-out of clearing requirements and elective clearing (§ 723)
• Real-time public reporting of Swap data (§ 727)
• Reporting of Swap data for use by regulators (§ 729)
• Swap Confirmation and documentation standards (§ 731)
• Credit support requirements for uncleared Swaps (§ 731)
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– “Pre-enactment Swap” and “Transition Swap” Reporting (§ 723):
• “Pre-Enactment Swaps”: entered into prior to enactment of DoddFrank on July 21, 2010 and not yet expired as of such date.
• “Transition Swaps”: entered into on or after effective date of DoddFrank, but prior to the effective date of CFTC’s final Swap data
reporting rules.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– “Pre-enactment Swap” and “Transition Swap” Reporting (§ 723):
• General Rule: Data for pre-enactment Swaps and transition Swaps
must be reported to a Swap Data Repository (“SDR”) or the CFTC.
• If pre-enactment and transition Swap data is timely reported, such
Swaps are exempt from further clearing requirements.
• A counterparty must maintain records of its pre-enactment and
transition Swaps for the duration of the Swap plus 5 years.
– See Proposed Rule on Swap Recordkeeping and Reporting
Requirements: Pre-Enactment and Transition Swaps (76 Fed.
Reg. 22,833) (April 25, 2011).
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Clearing Requirements (§ 723):
• Must opt-out of mandatory clearing by notifying the CFTC of how it
generally meets its financial obligations associated with entering
into non-cleared Swaps.
– CFTC Proposed Rule on End-User Exception to Mandatory
Clearing of Swaps (75 Fed. Reg. 80,747) (12/23/2010).
• Submission is made through a Swap Data Repository (“SDR”) upon
execution of a Swap.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Clearing Requirements (§ 723):
• Even if a Swap is not required to be cleared, the End User has the
right to:
– Require that the parties clear the Swap; and
– Select the Derivatives Clearing Organization (“DCO”) for
clearing.
• Practice Points:
– End Users must interact with SDRs and the CFTC to avoid
clearing
– End Users can opt-in for clearing.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Real-Time Public Reporting of Swap Data (§ 727):
• Certain data for all Swaps (whether cleared or not) must be made
publicly available “as soon as technologically practicable” after the
Swap has been “executed”.
• Off-facility Swap transactions between End Users will need to be
reported by one of the End User parties.
• Reported information must not identify the parties to the Swap
transaction.
• Reported to a “real-time disseminator”.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Real-Time Public Reporting of Swap Data (§ 727):
• “As soon as technologically practicable”: “As soon as possible,
taking into consideration the prevalence, implementation and use of
technology by comparable market participants”.
• “Execution” = agreement by the parties (whether orally or in writing)
that binds the parties.
– Not necessarily the same as signing a Confirmation.
• See Proposed Rule on Real-Time Public Reporting of Swap
Transaction and Pricing Data (75 Fed. Reg. 76,139) (12/7/2010).
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Real-Time Public Reporting of Swap Data (§ 727):
• Practice Points:
– Be aware that End Users still may have to report.
– Are your internal operations/systems ready?
– Reporting is required upon “execution”. How does this align
with your internal Confirmation procedures?
– Do you need to update confidentiality provisions in your
gas/power contracts?
– Even if you are not the reporting party, note that information
about your gas/power Swaps will be made public.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Reporting to SDRs and Recordkeeping (§ 729):
• At least one party to a Swap must report Swap data to a registered
SDR or the CFTC.
– While § 727 relates to real-time public reporting, § 729 relates
to records/reports for use by regulators.
• Initial Swap creation data and ongoing Swap continuation data must
be reported.
• Depending on whether a Swap is cleared and/or executed on an
exchange, an End User may have to report.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Reporting to SDRs and Recordkeeping (§ 729):
• Records must be “readily accessible”:
– Throughout the life of a Swap; and
– For 2 years following termination or expiration.
• Records must be kept:
– Throughout the life of a Swap; and
– For 5 years following termination or expiration.
• See Proposed Rule on Swap Data Recordkeeping and Reporting
(75 Fed. Reg. 76,573) (12/8/2010).
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Reporting to SDRs and Recordkeeping (§ 729):
• Practice Points:
– System/Operations issues:
» Monitor and initially report Swap creation data.
» Continue to report Swap continuation data.
– Data retention and storage policies to comply with CFTC
recordkeeping requirements.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Confirmation and Documentation Standards (§ 731):
• The Act imposes significant documentation standards on MSPs and
SDs when dealing with End Users:
– Strict timing requirements for executing and confirming Swaps.
– Procedures for terminating offsetting Swaps with End Users.
• See Proposed Rule on Swap Trading Relationship Documentation
Requirements for Swap Dealers and Major Swap Participants (76
Fed. Reg. 6715) (Feb. 8, 2011)
• Practice Point:
– Changes are coming that impact how Swaps are documented.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Credit Support for Uncleared Swaps (§ 731)
• If an MSP or SD enters into an uncleared Swap with an End User,
initial and variation margin is not expressly required by the CFTC.
• However, the parties must enter into a credit support arrangement
(which may contain margin requirements).
– See Proposed Rule Regarding Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap
Participants (76 Fed. Reg. 23,732) (April 28, 2011).
• Practice Point: End Users will need to enter into credit
arrangements to comply with CFTC regulations.
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I. Who Does Dodd-Frank Affect?
What do End Users have to do?
– Trickle-down effect of MSP & SD regulations: two examples-• Margin requirements (§ 731): increased margin and
collateral costs required by the CFTC likely will be passed
through to End Users.
• Clearing requirements (§ 723): general cost of clearing
transactions may be reflected in higher prices to End Users.
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II. What should you be doing now?
•
Evaluate internal systems, processes, and
personnel
–
–
•
Who is responsible for reporting, recordkeeping, and ensuring
compliance?
What systems need to be updated?
Analyze the cost of compliance
–
Use of consultants may be necessary to fully analyze the scope of
compliance and to take next steps ensuring compliance.
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II. What should you be doing now?
•
Analyze the cost of alternatives to compliance
– Moving all of your business to physical instead of financial?
•
Does the use of only physical transactions make sense for your
business?
•
If you intentionally move all financial transactions to physical to
avoid Dodd-Frank requirements, are you “willfully evading” the
Act?
– Change business models altogether to avoid Dodd-Frank
compliance costs?
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III. Reading the Tea Leaves:
Where Will We End Up?
•
New Lawsuit Strategy?
– Scalia the Younger
– SEC’s “proxy-access rule” under Dodd-Frank struck down by
federal court of appeals in July.
• Basis: 1996 law requiring the SEC to promote “efficiency,
competition and capital formation”.
– Prompted direct attacks on Dodd-Frank regulations based on
the economic cost of a rule, regardless of its merits.
•
•
Analyze the CFTC’s cost-benefit analysis
Does it pass muster?
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III. Reading the Tea Leaves:
Where Will We End Up?
•
Impact of Legal Challenges on CFTC’s Approach:
– CFTC is rewriting Dodd-Frank rules to more fully analyze the
economic impact on business.
– Commissioner O’Malia: “We’re not there yet.”
•
Cost-benefit analysis must be bolstered for each rule to pass
judicial scrutiny.
– The rewriting process has already caused delays in voting on
position limit regulations. What’s next?
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III. Reading the Tea Leaves:
Where Will We End Up?
•
Implementation Delays?
– Effective Date for Swap Regulation (76 Fed. Reg. 42,508) (July
19, 2011).
•
The effective date for Title VII provisions referencing key
defined terms (e.g., Swap, MSP, SD) has been delayed
until the earlier of:
– The date definitional rulemakings become final, or
– December 31, 2011.
•
•
The repeal of CEA exemptions and exclusions has been
delayed until December 31, 2011.
Will there be another round of delays?
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III. Reading the Tea Leaves:
Where Will We End Up?
•
Proposed Timeline for Final CFTC Rules:
Remainder of
2011
•Clearinghouse rules
•Data recordkeeping and reporting
•End-User exception
•Entity definitions/registration
•External business conduct
•Internal business conduct
•Position limits
•Product definitions/commodity
options
•Real-time reporting
•Segregation for cleared Swaps
•DCMs and FBOTs
First Quarter
of 2012
•Capital and margin requirements
•Client clearing documentation and
risk management
•Conforming rules
•Disruptive trade practices
•Governance and conflict of interest
•Internal business conduct
•Investment of customer funds
•Swap Execution Facilities
•Segregation for uncleared Swaps
•Straight-Through Trade Processing
**Source: Chart published on CFTC website as of September 8, 2009.
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III. Reading the Tea Leaves:
Where Will We End Up?
•
Pushback from Congress?
– Budget Fights in Washington:
•
Senate approved 19% increase of CFTC’s 2012 budget
–
•
Still must be passed by the full Senate.
Will the House approve the budget increase?
–
–
In June, the Republican-controlled House denied Obama’s request to
increase CFTC funding for 2012.
Passed appropriations bill that decreased the CFTC’s 2012 budget.
– Dodd-Frank = Big Government?
– Tea Party effect
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III. Reading the Tea Leaves:
Where Will We End Up?
•
Transition to Physical?
– Any migration will be slow
– Unclear how far this will go, especially because of CFTC
jurisdiction questions
– Financial is easier
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III. Reading the Tea Leaves:
Where Will We End Up?
•
New CFTC Director: Division of Swap Dealer and
Intermediary Oversight
– New York derivatives attorney, not banker or politician
– Will this result in a more pragmatic approach?
•
Continued pushback on “End User” definition:
– Everybody wants some
– How about you?
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IV. Conclusion
•
An End User is not exempt from Dodd-Frank simply
because it meets the Act’s definition.
•
Identify the regulations and requirements that apply to
your particular business.
•
Analyze internal systems, operations and processes to
ensure compliance.
•
Monitor CFTC rulemaking updates to avoid surprises.
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Should you be focused on the
Dodd-Frank Act?
YES!!!
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Questions?
Craig R. Enochs
[email protected]
Tel: (713) 752-4315
Kevin M. Page
[email protected]
Tel: (713) 752-4227
Jackson Walker L.L.P.
1401 McKinney, Suite 1900
Houston, Texas 77010
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