United States: Potential Impact Of The U.S. Dodd-Frank Act And Global OTC Derivatives Regulations

In connection with any over-the-counter ("OTC") derivatives transactions you execute with U.S. entities and certain entities registered as "swap dealers" or "major swap participants," you may need to determine the potential impact of U.S. OTC derivatives regulation on your business and trading activities. The U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") is part of a global effort to meet commitments of the Group of Twenty Finance Ministers and Central Bank Governors ("G-20") on OTC derivatives regulation. It is important to review the potential impact of U.S. regulations under Dodd-Frank on your OTC derivatives transactions and how they may interact with OTC derivatives regulation being developed in your home jurisdiction and elsewhere in the world.

Specifically with respect to the U.S., the reach of Dodd-Frank on your activities will depend on the extent to which you enter into swaps with U.S. persons—keeping in mind that the term "U.S. person" has not been finalized by U.S. regulators. If you enter into swaps with these counterparties, along with certain entities registered as swap dealers or major swap participants, you may be subject to certain Dodd-Frank provisions with respect to registration and/or transaction requirements. In addition, you should note that the regulation of OTC derivatives transactions in the U.S. is split among multiple regulatory bodies including the Commodity Futures Trading Commission ("CFTC") and the Securities and Exchange Commission ("SEC"). The following discussion describes in broad terms the potential impact on your company of planned OTC derivatives regulation under the G-20 commitments and Dodd-Frank.

Swaps

Dodd-Frank regulates swap transactions and, to various degrees, the parties who enter into swap transactions. What is and is not a swap is a very complicated question. Dodd-Frank and U.S. regulators define "swaps" broadly so as to capture an extensive array of OTC derivatives transactions. In certain cases, such as, for example, interest rate swaps, it is a relatively straightforward analysis to determine that such a transaction falls within the definition of "swap" and is thus subject to Dodd-Frank. In other cases, such as forward transactions, determining whether that transaction is a swap or is a type of OTC derivatives transaction outside of the reach of Dodd-Frank may require complex analysis of the terms of the transaction and the facts and circumstances surrounding the execution of the transaction.

Registration

Dodd-Frank governs certain participants in swaps markets. If you engage in significant swap transactions, you yourself might be subject to registration as a swap dealer or major swap participant. Determining whether or not your swap activity is significant enough to require registration requires both a quantitative analysis as well as a facts and circumstances analysis. Swap participants are required to register with the applicable U.S. regulator if they exceed certain thresholds in connection with their swap transactions with U.S. persons. A key challenge is to determine which swap transactions should be included and excluded from these thresholds and how these thresholds should be calculated. Those not presently subject to registration may nevertheless need to carefully monitor their swap activities if they have significant aggregate swap positions either to determine when and if they (or their affiliates) would need to register in the future or to take appropriate steps to avoid the registration requirements.

If required to register, you may become obligated to satisfy extensive regulatory obligations on the conduct of your business and financial requirements. You would also be subject to margin and capital requirements with respect to your swap positions.

Cleared and Uncleared Swaps

Historically, most swaps were privately negotiated transactions entered into between parties on a bilateral basis. Dodd-Frank, consistent with efforts of other G-20 countries, imposes a mandatory clearing requirement on many swap transactions. As a result, going forward, many of your swaps may be required to be cleared through clearing houses. Under Dodd-Frank, swap transactions with standardized terms and high levels of liquidity are subject to mandatory clearing.

The CFTC recently finalized rules requiring mandatory clearing of certain interest rate swaps and credit swaps. These requirements will phase in during 2013 depending on the type of entity entering into these swaps that are subject to mandatory clearing. As required under Dodd-Frank, going forward the CFTC will from time to time propose other categories of swaps that will be subject to mandatory clearing.

Exceptions to the clearing requirement are available to certain market participants, in which case you may need to take steps to ensure that you can take advantage of these exceptions if it is economically beneficial to do so. Nonfinancial entities that are using swaps to hedge or mitigate commercial risk may be eligible to elect the "end user clearing exception" if they meet certain requirements and follow certain procedures. This exception allows parties satisfying the end user exception to continue to enter into swaps on a bilateral basis as they have done in the past. The clearing requirements for "end users" with respect to interest rate and credit swaps identified by the CFTC will become effective in the third quarter of 2013 unless the end user has previously taken the necessary steps to take advantage of the end user exception.

Generally, financial institutions, investment vehicles, and asset managers would not be able to take advantage of this exception. If you are not eligible for the clearing exception, in order to continue to enter into those swaps that are subject to mandatory clearing, you must enter into new documentation for cleared swaps. Clearing documents can be very complicated and may take a significant amount of time to negotiate, so it may be advisable to commence this process as soon as possible.

Cleared swaps are subject to margin (collateral) requirements imposed by both clearing houses and the clearing members through which cleared swaps must be traded. Uncleared swaps may also be subject to margin requirements, although at present, the rules governing the amount of margin for uncleared swaps have not been finalized. Further, the dealers with whom you enter into uncleared swaps are expected to be subject to additional capital requirements for those swaps. Therefore, even those swap participants who can take advantage of the end user exception may want to keep open their option to clear some of their swap transactions, even if those transactions are otherwise eligible to be entered into on an uncleared basis. It is possible that the cost of entering into certain uncleared swaps, after taking into account capital and margin requirements (and other costs associated with potentially less liquidity), may actually be greater than the cost of entering into a comparable cleared swap. Accordingly, even if you have the right to enter into uncleared swaps, you should nevertheless consider entering into new documentation for cleared swaps.

Overall, the establishment of a clearing requirement for an OTC derivatives market that was previously unregulated may result in the need to reevaluate the relative costs of entering into cleared swaps, uncleared swaps, and futures contracts and any associated new regulatory requirements. Regulators in various jurisdictions will determine which categories of OTC derivatives transactions will be subject to mandatory clearing requirements and exceptions to the mandatory clearing requirements, as well as the costs imposed on cleared and uncleared transactions. G-20 regulators have agreed in principle to harmonize their regulations to the extent appropriate. Nevertheless, there are likely to be differences among jurisdictions as to which swaps must be cleared and the relative costs of entering into cleared versus uncleared swaps. Therefore, you may want to weigh the relative merits of transacting in these different jurisdictions and shift, where appropriate and lawful, your swap trading activities to jurisdictions where the costs and regulatory burdens of trading certain swaps are more beneficial.

Exchanges and Electronic Platforms

The G-20 has proposed that standardized OTC derivatives transactions trade on exchanges or electronic platforms where appropriate. Key features of these exchanges and electronic platforms include standardization of products, pre- and post-trade transparency, automated post-execution processes, and market surveillance. The forms of these exchanges and electronic platforms may vary significantly from one jurisdiction to another, and they could include venues that trade on a fully multilateral basis using well-defined rules about how multiple orders interact, venues that facilitate bilateral transactions with limited restrictions on what can be traded and how the transactions are executed, and venues that blend elements of multilateral and bilateral trading mechanisms. You may need to evaluate trading strategies with respect to these venues and the products offered on different platforms (and if those products are subject to mandatory clearing requirements) and related costs.

Under Dodd-Frank, all swaps subject to mandatory clearing will eventually be required to be traded on "swap execution facilities," but the rules governing these facilities and the final form they will take have not been finalized.

Extraterritoriality

The extent to which the various rules and regulations of Dodd-Frank apply to the swap activities of non-U.S. persons or to swap transactions entered into outside of the United States is a very complicated and controversial issue. As proposed, many Dodd-Frank requirements extend well beyond the shores of the U.S. Even for non-U.S. persons who enter into swaps outside of the United States, determining the extent to which those swaps may be subject to at least some of the Dodd-Frank requirements can be a complicated task. Many of the relevant regulations are also not final, such as rules addressing the regulatory treatment of non-U.S. persons registered as swap dealers or major swap participants, which adds to the complexity. The extraterritorial reach of new financial regulations, however, is not an issue unique to Dodd-Frank. Many of the new financial reforms currently contemplated by the EU also extend well beyond the shores of the European Union.

The CFTC and the SEC are working with their counterparts in other jurisdictions to reach consensus to minimize conflicting regulatory requirements as well as regulatory gaps. A stated goal of the G-20 is to avoid, to the extent possible, the application of conflicting rules to the same entities and same transactions. Despite these efforts of regulators, as noted above, you may still find yourself navigating inconsistent treatment due to various jurisdictions' differences in laws, policies, markets, implementation timing, and legislative and regulatory processes.

Reporting

You or your counterparties may be required to report the swaps you enter into to trade repositories. By collecting, storing, and disseminating data on swap transactions, these trade repositories will provide transparency to regulators to monitor risks in the market and act as a source of information to market participants and the public. You may need to coordinate various reporting requirements and exclusions for swap transactions in different jurisdictions. The choices for compliance may also differ depending on the type of transaction, the counterparty to the transaction, and the manner in which the transaction is executed. Compliance with reporting requirements may affect your information technology systems, trading desk and back office operations, risk and compliance functions, and existing policies and procedures. In certain circumstances, modifications to your information technology systems may be extensive and require significant lead time. Recordkeeping requirements may equally apply to the swap transactions that are covered by these reporting requirements.

Generally, the rules under Dodd-Frank require that, where one of the parties to a swap transaction is a registered swap dealer or major swap participant, the reporting obligation falls upon the registered entity. In circumstances where neither party to a swap is a registered entity, if at least one party to the transaction is a U.S. person, it is the designated reporting party. In other words, if you are transacting swaps through entities that are non-U.S. persons (assuming you are not a registered entity), then you should not be required to report transactions under Dodd-Frank. However, depending on the pending final definition of "U.S. person," your subsidiaries and other affiliates may constitute U.S. persons for purposes of reporting requirements. The procedures for reporting transactions under CFTC final reporting rules and SEC proposed reporting rules are different.

Documentation/Policies/Procedures

Even for swaps not subject to mandatory clearing, the documentation governing those swaps must be amended to address the Dodd-Frank regulatory requirements being imposed on designated market participants. In circumstances where your swap counterparties are certain registered swap dealers or major swap participants, you may need to amend or execute new trading documentation to address those regulatory requirements. Your risk management and compliance functions may also need to adopt or update policies and procedures, which should account for the OTC regulations in each of the jurisdictions in which your company is transacting.

The International Swaps and Derivatives Association has issued and will issue in the future various protocols for amending bilateral swap documentation to address changes under Dodd-Frank. Some market participants are adopting these protocols with no alterations, while other market participants are adopting these protocols subject to certain modifications.

Next Steps

To assess the potential impact of global OTC regulations and Dodd-Frank you should review your OTC derivatives transactions and the identity and regulatory status of your counterparties to determine your exposure to various requirements. This analysis will be complicated by the lack of complete rules and the ambiguities arising under newly issued rules that have not been tested in the market. Cross-border harmonization of global OTC regulations is still a work-in-progress, and while the intent expressed by the G-20 is to allow parties to choose to comply with one set of rules in situations where the rules of two jurisdictions apply and are consistent with each other, the details for implementation have not been resolved. To address these and other challenges, various swap participants are phasing in compliance with Dodd-Frank based on final regulations while maintaining flexibility to adopt different approaches depending on how the remaining regulations under Dodd-Frank and the other global OTC derivatives regulations evolve. Based on the analysis of your OTC derivatives transactions, your exposure to Dodd-Frank and global OTC regulations may be minimal or it may be extensive, but in either case this review will enable you to assess their potential impact so that you can plan on prudent next steps.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Jonathan J. Ching
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.