This is part two in a three-part series on the hedging outlook for 2014. Last week, we reviewed current Fed Policy and discussed the impact on hedging programs in 2014. This week, we look at the path of derivatives regulation and the expanding role of global regulation on domestic hedging programs.
Part II: Derivatives Regulation. Hedging programs in the U.S. changed monumentally over the past year. A veritable alphabet soup of regulatory requirements was heaped upon market participants, including the following:
– ECP: Now all market participants must be Eligible Contract Participants (ECPs), or be qualified so by virtue of certain qualifying owners or guarantors.
– LEI: Each hedging party must obtain and maintain a Legal Entity Identifier (LEI).
– End-User Exception: All parties to a new transaction who are eligible to do so must now preserve the right to enter into uncleared derivatives, lest they be required to clear.
– Central Clearing: Several of our clients set up clearing relationships with one or more Futures Commission Merchants (FCMs) in 2013, and now regularly centrally clear their deals that can be cleared.
– Swap Documentation: Parties who wished to continue to trade with a swap dealer or major swap participant had to adhere to certain protocols that wrapped new business conduct rules and swap trading relationship documentation requirements around their deals.
– Portfolio Reconciliation: A requirement to reconcile portfolios of swaps began in 2013, with swap dealer banks eager to comply with the mandate to at least offer such services and agree to terms with their clients in 2013.
– Reporting: Swaps were required to be reported to a swap data repository for the first time in 2013.
New market participants may not appreciate the evolution, but for anyone involved in the Dodd-Frank process to date, just understanding the rules and setting out on a path to compliance was a huge task in 2013.
As with the FOMC, a new chairman will also take over the CFTC, with nominee Timothy Massad expected to replace outgoing chairman Gary Gensler soon. There are many small compliance issues that need to be addressed this year for the first time, including renewal or “maintenance” of one’s LEI on the anniversary of first obtaining it (and annually thereafter). Public entities whose boards approved the ability to opt out of central clearing get to revisit their decision in another recurring requirement.
Additionally, there are also several new compliance events for some market participants in the coming year:
– Swap Execution Facilities (SEFs): The biggest news on the horizon for financial entities this year is the advent of trading on SEFs, with mandatory trading for certain trades as early as mid-February. This only impacts parties that are required to clear, and only those trades that have been made available to trade (“MAT”) on a particular SEF thus far. There are now 11 registered SEFs operating in the interest rate asset class, many of which are already accepting the type of trades soon to be required. As with any new market, attracting liquidity is a huge concern, as well as a SEF’s ability to support new technical requirements. As additional clearing and MAT determinations are made (e.g., for FX trades or amortizing swaps), SEF usage will grow over time.
– European Requirements: Along with SEFs, many clients engaging in swaps in 2014 with European banks or affiliates will have to understand their new obligations under the European equivalent of Dodd Frank, known as EMIR. For those entities that have their hands in both Dodd Frank and EMIR, extraterritoriality issues and substituted compliance could dominate the regulatory conversation. European reporting requirements begin to take effect this coming February.
– Margin: While margin requirements for uncleared swaps will not take effect in 2014, margin rules are likely to be finalized, setting up a potentially significant shift in how and under what circumstances trades will need to be collateralized. Early preparation for compliance will involve negotiating ISDA Credit Support Annexes or other standardized industry documentation.
While much of the heavy lifting with regulation and compliance is done, pronouncements from last year will join new requirements to impact your swap programs this year. Additionally, those transacting across borders may find the regulatory journey continuing for years to come as foreign regimes begin transitioning into a higher gear in order to avoid having Dodd-Frank’s requirements apply to transactions in their domestic markets. At Chatham we continue to consult clients on how to navigate the new rules and comply with those rules that are finalized and in place. Don’t hesitate to contact us if we can be of service to you, too!
Don’t forget to tune in next week for part three in this three-part series on the hedging outlook for 2014, Part III: Hedge Accounting
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