In order to facilitate compliance with certain rules described below (the "Covered Rules") that have been promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. No. 111-203, 124 Stat. 1376 (2010)) (the "Dodd-Frank Act") and that will become effective on October 12, 2012, the International Swaps and Derivatives Association, Inc. ("ISDA") has launched the ISDA August 2012 Dodd-Frank Protocol (the "Protocol"), which provides for certain standardized amendments to existing ISDA documentation. The Protocol is open to both ISDA members and non-members. This update will briefly describe the documentation and procedures for the Protocol. Information about the Protocol can also be found on ISDA's website.
A swap counterparty that does business with swap dealers or major swap participants may not be able to enter into new swap transactions on or after October 12, 2012, unless the counterparty has previously supplied the information required by and has adhered to the Protocol before that date. Counterparties may want to consider promptly contacting their swap dealers or major swap participants regarding the procedures to implement the Protocol.1
The Covered Rules
On August 13, 2012, the Commodity Futures Trading Commission (the "CFTC") and the Securities and Exchange Commission published in the Federal Register their joint final rule (the "Final Rule") defining the term "swap" and addressing certain other matters.2 The Final Rule goes into effect on October 12, 2012. The effective date of the Final Rule also triggers the effectiveness of certain other rules previously promulgated by the CFTC under the Dodd-Frank Act, including the rules described below:
- Prior to executing a transaction with a counterparty, each swap dealer must implement "know your counterparty" policies and procedures reasonably designed to obtain and retain certain facts regarding the counterparty, including:
- facts required to comply with applicable laws, rules and regulations;
- facts required to implement the swap dealer's credit and operational risk management policies; and
- information regarding the authority of any person acting for the counterparty.
- Prior to executing a transaction with a counterparty, each swap dealer and major swap participant (collectively referred to herein as a "Designated Swap Party") shall obtain and retain a record showing:
- the true name, address and principal occupation or business of the counterparty; and
- the name and address of any other person guaranteeing the performance of the counterparty and any person exercising control with respect to the positions of the counterparty.
- Before offering to enter into or entering into a swap that is not initiated on a designated contract market or a swap execution facility, a Designated Swap Party must verify that the counterparty meets the eligibility requirements as an eligible contract participant ("ECP"); determining whether a counterparty is an ECP may require certain detailed information regarding the financial status and operations of the counterparty.
- The CFTC's Dodd-Frank rules also impose certain additional diligence and disclosure requirements (a) for swap dealers that recommend a swap (or a trading strategy for a swap) to a counterparty and (b) for Designated Swap Parties that enter into swaps with a "special entity," which includes certain federal, state and local governmental entities and certain employee benefit plans.
- A Designated Swap Party may rely on written representations of a counterparty to satisfy the due diligence requirements described above.
- In addition to the foregoing rules, the October 12 effective date also applies to CFTC rules regarding record keeping and reporting requirements applicable to Designated Swap Parties as well as rules establishing position limits on speculative positions for certain physical commodity futures and swaps and rules addressing certain other matters.
The Protocol is designed to facilitate compliance with the Covered Rules by supplementing existing master agreements or other written agreements ("Existing Swap Agreements") relating to swaps. As to swaps that are not governed by a master agreement or other written agreement, the Protocol contemplates that the parties to such swaps would enter into an ISDA August 2012 DF Terms Agreement (a "DF Terms Agreement"), which is a "bare-bones" agreement that provides for the incorporation of certain Schedules to the DF Supplement referred to below and includes certain basic representations, a governing law clause, and certain other miscellaneous provisions. The Protocol documents contain representations, covenants, and notice provisions that are intended to satisfy certain provisions of the Covered Rules, which must be complied with when swaps are offered or entered into. The Protocol documents are briefly described below. The Protocol does not provide a method for negotiating or altering the terms of the standard Protocol documents, but parties to Existing Swap Agreements could presumably modify the standard terms by entering into a side agreement outside of the Protocol.
ISDA August 2012 DF Protocol Agreement
The ISDA August 2012 DF Protocol Agreement (the "Protocol Agreement") sets forth the procedures by which Existing Swap Agreements and DF Terms Agreements (collectively, the "Protocol Covered Agreements") will be supplemented and amended pursuant to the Protocol. If a counterparty has several Existing Swap Agreements with a number of different Designated Swap Parties, the Protocol could be employed to amend all such Existing Swap Agreements at the same time in order to comply with the Covered Rules. In order to effectuate such amendments pursuant to the Protocol, the counterparty would have to execute and deliver online a single Adherence Letter and complete one or more Protocol Questionnaires, as described below. If each Designated Swap Party for such Existing Swap Agreements has also executed an Adherence Letter and completed the relevant portions of one or more Protocol Questionnaires, then the Existing Swap Agreements would be deemed to have been amended based upon the elections made in the Protocol Questionnaires delivered by the counterparty and each relevant Designated Swap Party to each other in accordance with Protocol process. Thus, in summary, the counterparty and each relevant Designated Swap Party could amend and supplement an Existing Swap Agreement (or, as to undocumented swaps, could enter into a DF Terms Agreement) by executing Adherence Letters and exchanging appropriately completed Protocol Questionnaires.
ISDA August 2012 DF Supplement
The ISDA August 2012 DF Supplement (the "DF Supplement") contains representations, covenants and other agreements that are intended to facilitate compliance with the Covered Rules and that are incorporated into Existing Swap Agreements via the Protocol process. The DF Supplement consists of a one paragraph introduction and six Schedules:
- Schedule 1 – Defined Terms
- Schedule 2 – Agreements between a Swap Dealer and Any Other Party
- Schedule 3 – Institutional Suitability Safe Harbors for Non-Special Entities
- Schedule 4 – Safe Harbors for Non-ERISA Special Entities
- Schedule 5 – Safe Harbors for ERISA Special Entities (Option 1)
- Schedule 6 – Safe Harbors for ERISA Special Entities (Option 2)
Each party who has executed an Adherence Letter (an "Adhering Party") will be deemed to have agreed to Schedules 1 and 2. However, certain of the provisions of Schedule 2 would only apply to an Adhering Party if that party meets the requirements described in the provisions. For example, the provisions of Part III of Schedule 2 to the DF Supplement (Representations and Agreements of a Counterparty that is not a Swap Dealer) would only apply to Adhering Parties that are not swap dealers. Schedules 3 to 6 are optional and would only apply if both parties to a Protocol Covered Agreement have elected to incorporate one or more of such Schedules on the Protocol Questionnaires for both such parties. Thus, for example, if an Adhering Party is not an ERISA Special Entity and is not a swap dealer who has entered into swaps with an ERISA Special Entity, that Adhering Party would not complete the provisions of the Protocol Questionnaire incorporating Schedule 5 or Schedule 6 to the DF Supplement.
The Schedules should be carefully reviewed because they impose ongoing obligations on each Adhering Party. For example, under the provisions of Section 2.3 of Schedule 2, an Adhering Party agrees to provide prompt notice in writing to the other party of material changes to certain information supplied by the Adhering Party in connection with the DF Supplement.
ISDA August 2012 DF Protocol Questionnaire
The ISDA August 2012 DF Protocol Questionnaire (the "Protocol Questionnaire") must be completed online by each Adhering Party. Under the Protocol Questionnaire, the Adhering Party will:
provide general information regarding the Adhering Party, including the Adhering Party's true name and address, principal occupation or business, an email address for the delivery of required notifications and disclosures, and other pertinent information;
complete provisions that result in an Adhering Party's making representations about its legal status, such as a representation that an Adhering Party is a commodity pool, eligible contract participant, swap dealer, or major swap participant; and
make various elections under the DF Supplement, including an election as to the particular Schedules of the DF Supplement that will amend the Adhering Party's Protocol Covered Agreements.
An Adhering Party may elect to have its Protocol Questionnaire delivered only to other Adhering Parties that have been approved by the delivering Adhering Party and may complete more than one Protocol Questionnaire so that different Protocol Questionnaires can be delivered to different counterparties. The Protocol Questionnaire will be delivered online via a platform developed by ISDA and Markit; further information about the platform and the Protocol process may be found on Markit's website. The Protocol Questionnaire is being rolled out in two phases. Phase 1 will allow the parties to complete Part II, Sections 1 through 5 of the Questionnaire, which was made available on August 13, 2012. Phase 2 will allow the parties to complete the remainder of the Questionnaire, which will be available on September 10, 2012.
I n order to accept the terms of the Protocol, a party must sign and deliver an Adherence Letter, which will contain the party's name, address, and other non-sensitive information, and pay an adherence fee of US $500.00. Signed Adherence Letters will be uploaded and available for public view.
1. The Protocol process is not legally required, and it is legally permissible for a counterparty, on the one hand, and a swap dealer or major swap participant, on the other, to enter into a bilateral agreement amending their existing swap documents in order to comply with the Dodd-Frank Act and the rules promulgated thereunder. However, under the Dodd-Frank rules as currently in effect, the bilateral amendment would have to be in place by October 12, 2012.
2 The Final Rule is discussed in a prior V&E Finance Update dated July 16, 2012.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.