United States: New Swap Business Conduct And Record-Keeping Regulations Kick in For Municipal Bond Issuers And Borrowers

Beginning May 1, 2013, many new business conduct regulations adopted by the Commodity Futures Trading Commission ("CFTC") pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") will begin to take effect. Although the requirements of the new regulations apply on their face just to swap dealers and major swap participants, any end users (including bond issuers and borrowers) that are parties to a swap agreement will need to amend their master agreements to provide information and make representations to dealers in order to enter into new swaps with such dealers after May 1. In addition to the business conduct regulations, there are various new reporting and record-keeping requirements that must be satisfied regarding the end user's existing and new swaps. There are also special rules that apply to municipal bond issuers that qualify as "special entities" under the regulations. This advisory addresses some of the more common questions regarding this new regulatory regime.

What types of derivatives are covered by the CFTC regulations?

Dodd-Frank regulates swap markets, giving regulatory jurisdiction over some kinds of swaps to the CFTC and jurisdiction over others to the SEC. The kinds of swaps most commonly used in connection with municipal bond issuances, including interest rate swaps, are regulated by the CFTC under the Commodity Exchange Act. Swaps, including credit default swaps, based on the return of broad-based indices (including broad-based municipal securities indices) are also under the CFTC regime. Commodity derivatives, such as fuel swaps, are under the CFTC regime unless they fall into an exception for forward delivery agreements.

The kinds of swaps that will be under the SEC regime when the SEC's final rules are issued and go into effect are called "security-based swaps" and include swaps based on the yield of individual debt securities, and swaps based on the value or return of narrow-based securities indices and baskets (including narrow-based municipal securities indices and baskets). Financial guarantees, such as bond insurance or bond wraps, will not be treated as swaps or security-based swaps so long as the right to accelerate payments is exclusively the insurer's and other conditions are met.

What does an end user need to do with regard to its existing swaps if it has no current plan to enter into additional swaps?

End users that are parties to existing swaps are subject to certain requirements, even if they do not intend to enter into any new swaps for the foreseeable future. (For the purposes of the regulations amending the material terms of an existing swap may constitute entering into a new swap). As described in a previous alert, all parties to existing swaps are required to obtain an identification number known as a CICI. If the end user is a party to any "post-enactment swaps" (swaps that were executed after April 25, 2011, the date the Dodd-Frank Act went into effect), the regulations require the end user to obtain, or confirm its counterparty has obtained for it, a legal entity identifier using the CICI process by April 10, 2013, which deadline has been extended, for enforcement purposes, to October 31, 2013 by CFTC no action letter. End users that are only parties to "historical swaps" (i.e. any swap that is not a post-enactment swap) are not required to obtain a CICI until October 7, 2013.

All existing swaps are also subject to reporting requirements. Only one party to the swap is required to file the reports and in most cases the reporting burden will fall on the swap dealer, not on a municipal bond issuer or borrower. Since the majority of swaps done in the public finance context are between a municipal bond issuer or borrower and a swap dealer, most bond issuers or borrowers will not need to worry about the reporting requirement. However, beginning April 10, 2013, all swap parties must keep adequate records to allow their counterparties to comply with reporting requirements. The text of 17 CFR 46 contains tables of minimum primary economic terms data that all counterparties must maintain during the life of the swap and for five years thereafter. Such data includes the names and characteristics of the parties, the assets involved in the swap, the contract type, certain relevant dates and the price, rate, or notional amount of the swap, as applicable. There is no requirement that the records be kept in electronic form, only that they be kept in such a way that they may be easily accessed for reporting purposes. End users will not be required to create or re-create records that were not in their possession as of October 14, 2010, but they must retain the records that are currently in their possession (including records of swaps that have already expired) for a period of five years after the termination date of the applicable swap.

Even if an end user has made it clear that it does not intend to enter into new swaps, swap dealers may be reluctant to continue speaking with an end user that has not taken the steps required to enter into new swaps, as described below. Dealers will be required to record all conversations that could "lead to the execution of a swap" and to verify certain information about the end user before offering to enter into a swap. Additionally, dealers who are offering advice to "special entities" will be held to heightened standards of fair dealing, as further described below. Because it is difficult to pinpoint where in a conversation the intent to enter into a swap begins, many dealers may exercise caution and refuse to speak to end users that are not eligible to execute new swaps, in order to avoid inadvertently violating these regulations.

What must an end user do in order to continue entering into swaps?

Beginning May 1, 2013, all swap counterparties will be required to amend their master agreements in order to incorporate certain provisions required by the Dodd-Frank regulations. Although there is no penalty for missing this deadline, dealers will not enter into swaps with counterparties until the counterparties have provided certain information and addressed the new requirements in their master agreements. As discussed in further detail below, the master agreement amendments sought by dealers to comply with Dodd-Frank typically include the affirmation or waiver of certain new legal rights and obligations, such as the end user's right to restrict the dissemination of material confidential information, and, in the case of "special entities," such as municipal bond issuers, information and representations relating to new, heightened fair dealing duties on swap dealers.

What is the ISDA DF Supplement?

In 2012, the International Swap Dealers Association ("ISDA") released a document known as the ISDA DF Supplement that was intended to incorporate all of the recent regulations into a common amendment that would provide uniformity and allow both end users and swap dealers to comply with the regulations without needing to draft individual contracts.

The ISDA DF Supplement has two required components: Schedule 1, which contains defined terms, and Schedule 2, which incorporates most of the business conduct regulations issued by the CFTC. There are also four additional schedules (Schedules 3–6) that may be selected by an end user that is categorized as a certain type of entity under the regulations. Schedule 4 is the one that pertains to municipal special entities. However, it is not necessary to include Schedule 4 (or any of the other additional schedules), and an end user may refuse to add any without jeopardizing the validity of the remainder of the ISDA DF Supplement.

In connection with the ISDA DF Supplement, end users are also required to complete a questionnaire, known as the ISDA DF Protocol Questionnaire, which seeks more information about the entity entering into the swap, and its status under the regulations. The whole process of answering the questionnaire and executing the supplement is known as the August 2012 ISDA Protocol. (ISDA issued an additional protocol in March 2013 and is expected to issue future protocols as the CFTC and SEC finalize additional rules under Dodd-Frank.) In addition to determining whether the end user is a "special entity," the questionnaire in the August 2012 DF Protocol asks if the party is an "eligible contract participant" or a "swap dealer" under the law and if it has a third-party evaluator acting on its behalf when it enters into swaps. Although the questionnaire is relatively short, the responses to several of the questions involve legal conclusions, and such questions should not be answered without some review by counsel.

In order to adhere to the August 2012 ISDA Protocol and enter into an ISDA DF Supplement, the end user must complete the ISDA DF Protocol Questionnaire on the ISDA website, select the schedules it wishes to use, and submit it to ISDA for approval. This submission generates a document that serves as an amendment to an existing ISDA Master Agreement. Because ISDA has the authority to reject any nonconforming agreement, end users do not generally have the ability to modify individual terms. Instead, every end user must generally either accept or reject the agreement (including any required and selected schedules) in whole.

What are the alternatives to the ISDA DF Supplement?

End users that wish to continue entering into swaps are not obligated to use the ISDA DF Supplement. The purpose of the ISDA DF Supplement is to encourage compliance with the Dodd-Frank regulations, but this can also be achieved if the parties execute a bilateral amendment to their existing master agreement or agreements. Some swap dealers have drafted their own questionnaires and master agreement supplements to be used with their existing counterparties in lieu of the ISDA Protocol.

Which method should an end user use?

Although the ISDA Protocol provides administrative convenience, it also contains certain provisions that protect swap dealers in ways that go beyond what is required by the Dodd-Frank regulations. The regulations provide end users with certain new legal rights and impose heightened fair dealing duties on swap dealers and major swap participants. However, the regulations permit end users to waive certain of these rights in writing, and the ISDA DF Supplement contains some of the permissible waivers. For example, the ISDA DF Supplement contains provisions in which the end user consents to dissemination of material confidential information for the counterparty's marketing purposes. End users that execute the ISDA DF Supplement will therefore concede new rights they have gained under Dodd-Frank and the regulations, although the practical extent and materiality of those concessions remain to be seen.

Ultimately, an end user's decision to use the ISDA Protocol may be a matter of administrative convenience. Although the ISDA Protocol contains some dealer-friendly provisions, it is recognized as an acceptable template and nearly every swap dealer will be willing to enter into the ISDA DF Supplement with an end user. The ISDA Protocol will be particularly attractive to end users that have several ISDA master agreements in effect since they can all be updated simultaneously with a single execution of the ISDA Protocol. Unique bilateral agreements may provide an opportunity for end users to tailor an agreement in a way that impacts end users' interests more favorably than the ISDA DF Supplement. A bilateral agreement may require legal review and negotiation, and the bilateral agreements may need to be separately negotiated and worded in each case.

Are municipal bond issuers considered "special entities"?

Under the regulations, a swap dealer has a heightened due diligence responsibility when its counterparty is a "special entity." Most municipal bond issuers qualify as "special entities," as the definition includes any state, state agency, city, county, municipality, other political subdivision of a state, or any instrumentality, department, or corporation of or established by a state or political subdivision of a state. In contrast, obligors on conduit bonds will not constitute special entities unless they are a 501(c)(3) organization that is an endowment. Typical 501(c)(3) borrowers, such as schools and hospitals, do not qualify as special entities.

Under the regulations a swap dealer transacting with a special entity is presumed to be an adviser to that special entity and has a duty to make a reasonable determination that any swap or trading strategy involving a swap recommended by the swap dealer is in the special entity's best interests. However, the swap dealer can be relieved of this duty if it obtains a written representation from the special entity that it will not rely on recommendations provided by the swap dealer, and will rely instead on advice from a designated qualified independent representative ("Designated QIR"). A Designated QIR can be any individual or entity that has sufficient knowledge to evaluate the transaction and risks of a given swap, is independent of the swap dealer or major swap participant, undertakes a duty to act in the best interests of the special entity it represents, makes appropriate and timely disclosures to the special entity, evaluates the fair pricing and the appropriateness of the swap consistent with the entity's swap policy, and agrees to refrain from making certain political contributions.

How does Schedule 4 to the ISDA DF Supplement affect municipal bond issuers?

Schedule 4 to the ISDA DF Supplement contains language waiving the swap dealer's duty to recommend only swaps or swap trading strategies that it determines are in the special entity's best interests. Bond issuers and other special entities should bear in mind that even if they use the ISDA DF Supplement, they need not make the representations listed in Schedule 4. If such an end user declines to execute Schedule 4 (or cannot make the representations that Schedule 4 requires because, for example, it hasn't hired an independent analyst) the swap dealer will effectively assume a fiduciary duty towards that end user in the case of recommended swaps or swap trading strategies and must undertake the necessary diligence to comply with such duty. However, swap dealers may not wish to assume these additional duties and may cease acting as swap dealers to their existing special entity clients unless and until they receive the Schedule 4 waiver or, in the case of amendments not involving the ISDA DF Supplement, a comparable waiver. Alternatively, dealers may seek increased spreads on swaps with special entities that have not agreed to waive the new Dodd-Frank fiduciary duty to compensate for their greater degree of regulatory risk.

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
Steve Ganis
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Cadwalader, Wickersham & Taft LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Cadwalader, Wickersham & Taft LLP
Related Articles
 
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions