In the effort to implement the far-reaching restructuring of the over-the-counter derivatives market contemplated by the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"),1 two particular developments currently stand out for corporate end-users. First, the opening of the International Swaps and Derivatives Association's ("ISDA") DF Protocol (the "Protocol") on August 13, 2012;2 second, the rapidly approaching deadline for an end-user to determine whether it will elect to avail itself of the commercial end-user exception3 to the Commodity Futures Trading Commission's ("CFTC") requirement for the mandatory clearing of swaps.
This memorandum is limited in scope and provides a brief overview of the Protocol to assist corporate end-users in deciding whether to adhere to the Protocol. We will provide a similar overview of the end-user exception in a subsequent memorandum.
Key Features of the Protocol
In considering whether to adhere to the Protocol, corporate end-users should be aware that the Protocol:
- Offers an efficient solution to the immediate, as well as the ongoing, documentation challenges posed by Dodd-Frank and the related rulemakings.
- Enables corporate end-users to continue trading uninterruptedly on and after October 15, 2012.4 Practically speaking, it may be the only option.
- Despite the obvious practical benefits of the Protocol, it may present significant operational challenges for corporate end-users. In analyzing whether to adhere to the Protocol, corporate end-users should consider the following:
- The Protocol requires the delivery of considerable "know your customer" information and the making of extensive representations and covenants, including agreeing to the potential disclosure of sensitive information, including anonymous Swap transaction and pricing data and Material Confidential Information.
- Internal policies and procedures will need to be developed by corporate end-users to ensure that they are properly monitoring and complying with ongoing information and documentation requirements arising under the Protocol.
Overview of the Protocol
Various CFTC rules impose extensive requirements on swap dealers and their counterparties that must be satisfied prior to the time swap transactions are offered and entered into. To comply with such rules, all counterparties under existing swap agreements, including all ISDA Master Agreements, will be required to supplement such agreements prior to October 15, 2015.5 If counterparties do not supplement those agreements, swap dealers will not be able legally to offer or enter into new trades under those agreements. Although it might be possible in limited instances to timely supplement those agreements on a bilateral basis, ISDA developed the Protocol to facilitate compliance with these rules6 ("Covered Rules") by allowing market participants to amend their existing swap agreements ("Protocol Covered Agreements") multilaterally.
To adhere to the Protocol, an end-user must (1) submit an Adherence Letter to ISDA and (2) deliver a completed Protocol Questionnaire to each dealer with which it has agreements that it wishes to supplement. To facilitate the Protocol Questionnaire delivery requirements, ISDA, together with Markit, has developed an electronic platform, referred to as "ISDA Amend," which provides for the automated and centralized gathering of the information required in the Protocol Questionnaires and the secure electronic delivery of such information to counterparties.
In addition to the Adherence Letter and Protocol Questionnaire, the architecture of the Protocol includes three other documents, i.e., a DF Supplement, a Protocol Agreement and a DF Terms Agreement, each of which is discussed below.
An Adherence Letter must be signed and submitted by each party wishing to adhere to the Protocol. An adhering party must specify where and by what means (electronic or otherwise) it will receive Questionnaires from other parties participating in the Protocol.
Protocol Questionnaires must be completed and exchanged between adhering parties to supplement their mutual Protocol Covered Agreements. Protocol Questionnaires are the means by which an adhering party delivers necessary information about itself to its relevant counterparties. In its Protocol Questionnaires a corporate end-user will make certain representations, such as those regarding: (1) essential facts about itself; (2) its eligible contract participant or Special Entity status; (3) its elections under the DF Supplement, including the election of the particular DF Schedules that will supplement its Protocol Covered Agreements; (4) whether it is a "financial entity"; and (5) whether it consents to receive oral disclosure of pre-trade marks and basic swap terms (with written disclosure post-trade).
The DF Supplement sets forth certain standardized representations and covenants relating to the Covered Rules. These representations and covenants are contained in six "DF Schedules." However, Schedule 2 ("Agreements Between a Swap Dealer and Any Other Party") will likely be the primary focus for most corporate end-users.7 Note that Schedules 1 and 2 are automatically incorporated into Protocol Covered Agreements through the exchange of Questionnaires.
Under Schedule 2, both swap dealers and corporate end-users must make a series of representations and agreements, including, but not limited to:
- Representations that DF Supplement information furnished is true and complete in all material respects and that no DF Supplement representation is materially incorrect or misleading in any material respect;
- An agreement that no event of default, termination event or other similar event shall occur due to any DF Supplement information or representation being incorrect or incomplete or any breach of any DF Supplement agreement;
- An agreement promptly to notify the other party in accordance with the "Notice Procedures" of any material change in DF Supplement information previously provided, or if any representation previously provided has become incorrect or misleading in any material respect, agreement timely to amend any relevant representation;
- An agreement promptly to provide each party any information reasonably required for the other party to comply with Title VII of Dodd-Frank and the Covered Rules;
- An agreement to consent to the disclosure of trade information including a party's identity to an SDR or relevant regulators. Additionally, with respect to "international swaps," corporate end-users must agree to notify swap dealers of the identity of the non-U.S. trade repository to which it has reported the swap and the swap identifier used by the non-U.S. trade repository to identify the swap;
- An agreement of the corporate end-user, to as soon as practicable, but in no event later than 10 a.m. on the second business day after the occurrence, report any "life cycle event" relating to a corporate event; and
- An agreement on the part of the corporate end-user to consent to the disclosure of Material Confidential Information by the swap dealer to comply with a request of any regulatory authority or self-regulatory organization with jurisdiction over the swap dealer or of which swap delaer is a member. Additionally, corporate end-users must agree that any Material Confidential Information not prohibited by a non-disclosure agreement may be used or disclosed by the swap dealer in any manner that is not prohibited by the terms of such agreement. If a corporate end-user and swap dealer have not entered into a non-disclosure agreement, the corporate end-user must agree that the swap dealer is authorized to disclose Material Confidential Information to: (i) any affiliates, third-party service providers and (ii) associated persons for purposes of complying with risk, compliance and accounting policies of the swap dealer or its affiliates.
Under the Protocol Agreement, each counterparty makes certain representations regarding, among other things, its status, the validity and binding nature of the Protocol, and the process for amending agreements that govern the terms and conditions of one or more transactions in swaps.
DF Terms Agreement
The DF Terms Agreement allows parties to apply selected provisions of the DF Supplement to their swap relationship when such relationship is not governed by an existing swap agreement. The DF Terms Agreement will generally not be applicable to corporate end-users who elect to avail themselves of the end-user exception to the CFTC requirement for mandatory clearing of swaps, as uncleared swaps will almost always be evidenced by written agreements (i.e., "ISDAs" or "long-form confirmations").
We will continue to monitor and report on developments in this area.
1 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203 (2010).
2 ISDA has not set a cut-off date for the Protocol; however, ISDA reserves the right to close the Protocol upon giving 30 days' prior notice on their website. Once the Protocol closes, corporate end-users will not be able to adhere to the Protocol and will only have bilateral options available.
3 End-User Exception to the Clearing Requirement for Swaps, 77 Fed. Reg. 42560 (Jul. 19, 2012).
4 Although some corporate end-users who decline to adhere to the Protocol may be able to negotiate appropriate bilateral amendments to their existing swap agreements with particular dealers, that approach is not likely to be generally expedient given the intensive documentation demands which the derivatives market is currently experiencing
5 October 15, 2012 is the date on which swap dealers and major swap participants who registered as such must comply with the Business Conduct Standards and many other of the covered rules.
6 The Protocol is intended to address the requirements of the following final rules: Business Conduct Standards for Swap Dealers and Major Swap Participants with Counterparties, 77 Fed. Reg. 9734 (Feb. 17, 2012) ("Business Conduct Standards"); Large Trader Reporting for Physical Commodity Swaps, 76 Fed. Reg. 43851 (Jul. 22, 2011); Position Limits for Futures and Swaps, 76 Fed. Reg. 71626 (Nov. 18, 2011); Real-Time Public Reporting of Swap Transaction Data, 77 Fed. Reg. 1182 (Jan. 9, 2012); Swap Data Recordkeeping and Reporting Requirements, 77 Fed. Reg. 2136 (Jan. 13, 2012); Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 77 Fed. Reg. 20128 (Apr. 3, 2012) and Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps, 77 Fed. Reg. 35200 (Jun. 12, 2012).
7 Schedules 3-6 allow end-users that are able to make the representations required to establish the institutional suitability safe harbors available to swap dealers under the Business Conduct Standards to do so through these Schedules. Schedule 3 ("Institutional Suitability Safe Harbors for Non-Special Entities") is potentially relevant to corporate end-users; Schedules 4-6, which are safe harbors for Special Entities, are not applicable to corporate end-users.
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.