European Market Infrastructure Regulation (EMIR)

Beginning mid-March 2013, European entities will need to know and make representations regarding their regulatory status under EMIR. An entity’s regulatory status will determine the application of new EMIR requirements. In addition, non-EU entities that transact with EU counterparties should also consider their status under EMIR in order to determine how certain requirements may, directly or indirectly, impact them.

More Information: EMIR Overview

If you have any questions on EMIR, please don’t hesitate to reach out to your Chatham advisor.

Overview of Title VII of the Dodd-Frank Act

The Four Phases of Regulatory Engagement (aka the “LaRCO” Framework)

End users of derivatives have had to consider a multi-faceted approach for engaging withderivatives regulation. This approach includes four phases: Legislation, Regulation, Compliance and Optimization (“LRCO” or “LaRCO”). Each phase requires different competencies, has different objectives and different action steps. This framework is described as follows.

Chatham Regulatory Engagement


Legislation

Key Objective: Establish end user exemption and preserve efficiency of OTC derivatives market.

AIG’s synthetic bets (via derivatives) on the housing market contributed to its failure and government-funded bailout. In response, many policy makers questioned whether all derivatives should be forced into clearinghouses and exchanges or even banned altogether. Chatham, working together with numerous companies and the Coalition for Derivatives End-Users – a group of trade associations in Washington that represents the business community on derivatives policy issues – sought to tell how companies use derivatives to reduce, rather than increase risk. We emphasized that end users and the economy at large would be hurt by margin requirements. And we advocated for improvements to the law that would support end-users’ continued and efficient use of the OTC derivatives market. While the final law did not perfectly reflect the needs of end users – especially non-financial end users – policy makers did conclude that an end-user exemption would benefit the economy without undermining the core policy objectives of the Act.

Regulation

Key Objective: Preserve end user exemption and preserve efficiency of the OTC derivatives market.

While the Dodd-Frank Act did include an end-user exemption, it also gave regulators substantial authority – authority that could have served to substantially undermine the end-user exemption and the efficiency of the OTC derivatives market. Chatham, numerous companies, and the Coalition for Derivatives End-Users actively engaged through the regulatory process to ensure regulators understood how their actions would affect companies and the broader market. We wrote hundreds of pages of comment letters and met with regulators at the CFTC, SEC, Fed, FDIC, Treasury, White House and other regulatory agencies in dozens of meetings. The regulatory process is not complete, and while regulators have made great effort to understand andrespond to end-user concerns in many cases, the final outcome of the regulatory process on end-users is still difficult to assess. The ultimate outcome will substantially be determined by final decisions by bank regulators on capital and margin rules.

Compliance

Key Objective: Understand and meet legal requirements.

Even while legislative and regulatory initiatives continue, compliance deadlines are requiring companies to take action now. During this phase, it is essential for companies to understand the regulatory requirements that apply to them, to understand key timing deadlines and to take all necessary actions to comply with the law. Chatham has been working to educate clients and to design services that allow them to efficiently and effectively meet their legal requirements.

Optimization

Key Objective: Reassess hedging strategies in light of new regulatory requirements in order to make sure hedging strategies are optimized.

After clients have done what they need to do in order to meet their legal obligations, it will be time for them to focus on what they should do to ensure their hedging strategies are optimized. The need to optimize will be driven by changes in capital and margin requirements that create regulatory incentives to consider using cleared swaps, futures transactions, or hybrids thereof. These regulatory incentives may conflict with competing business incentives, such as the desire to preserve liquidity or obtain hedge accounting treatment. In order to assess the best hedging alternatives, companies will need to develop capabilities that allow them to compare alternative hedging options across six factors: transaction price, collateral, credit risk, economic fit, accounting effectiveness and portfolio effects. Chatham has been working to enable clients to analyze these factors in order to make wise hedging decisions during the optimization phase.

If you have questions about how Chatham can help you through these four stages or any of them individually, please contact your Chatham advisor.

Summary of Final Rule Further Defining a Swap

The definition of a “swap” was recently finalized and published in the Federal Register on August 13, 2012.

Summary of Final Rule Defining a Swap

Counterparty Risk and Collateral Protection

Counterparty Risk and Collateral Protection

ISDA August 2012 Dodd-Frank Protocol

Chatham clients are encouraged to contact your Chatham advisor for Step-by-Step instructions on the ISDA August 2012 Dodd-Frank Protocol.

In order to comply with certain Dodd-Frank regulations, all major US-regulated dealer counterparties must amend their existing ISDA agreements with their customers for any transactions taking place on or after January 1, 2013.

More Information: ISDA August 2012 Dodd-Frank Protocol

If you are a client, please let Chatham know that you have amended your ISDAs through ISDA Amend: In order to help us facilitate trading after January 1, 2013, please send your completed Protocol documentation to ISDAprotocol@chathamfinancial.com.

If you have any questions on the ISDA Protocol, please don’t hesitate to reach out to your Chatham advisor.

Overview of Reporting and Recordkeeping

Title VII of the Dodd-Frank Act, along with the rules promulgated by the Commodity Futures Trading Commission (“CFTC” or “the Commission”), institute new swap data recordkeeping and reporting requirements for OTC derivatives that are regulated as “swaps.” End users will be subject to these requirements as of April 10, 2013.

Regulators will require swap counterparties to maintain records and require certain data to be reported to a swap data repository (“SDR”) within specific timeframes. SDRs will warehouse the swap data and permit regulators access to monitor market stability, identify abuses, and enforce new rules. Additionally, real-time reporting requirements will increase price transparency to all market participants by providing a subset of data to the public on an anonymous basis.

Part 45 Recordkeeping & Reporting

– The swap data recordkeeping requirements under Part 45 will affect all counterparties to a swap – as each party will be required to keep and maintain full and complete records for the life of the swap and for five years after termination and be able to retrieve the records within five business days.

– The swap data reporting requirement under Part 45 requires data to be submitted to the SDR both initially and throughout the life of a swap. Only one of the two counterparties to a swap is responsible for the reporting requirement. An end user may be responsible for the reporting requirement only if it faces another end user; the vast majority of swaps will be reported by swap dealers and major swap participants. In situations where an end user must report, it is permitted additional time to do so.

– Parties will be required to obtain legal entity identifiers and maintain identifiers for each of their swaps. Regulators designated DTCC and SWIFT to issue legal entity identifiers. On August 21, 2012, the CFTC Interim Compliant Identifiers (CICI) web portal was launched. Below are the steps to obtain a compliant entity identifier:

1. Go to: www.ciciutility.org

2. View the Frequently Asked Questions for additional detail: FAQs on ciciutility.org

3. To register, select “Create New Account” in the top right.

4. Complete the form to create an account.

5. Once final, the system will send you an email. You must verify the email address first before being able to proceed.

6. Follow the steps to obtain an entity identifier. Please note the following:

a. The charge is USD 200 for an entity identifier and the fee must be paid by credit card before the entity identifier will be issued.

b. The FAQs state the following information is required: “legal name, the registered address of the entity, entity status, and the entity’s legal form.”

c. The CICI Utility is run by DTCC and SWIFT and they provided the following email address for support: CustomerService@ciciutility.org.

Part 43 Real-Time Reporting

– Part 43 requires certain pricing and volume data for each “publicly reportable swap transaction” to be reported to an SDR as soon as technologically practicable. As in Part 45, end users will not be responsible for the real-time reporting of swaps in which they face SDs or MSPs. Swaps between two end users are granted additional time to report. Swaps that are not executed at arm’s length (e.g., such as those between two affiliates owned fully by the same parent company) are not subject to real-time reporting requirements, though they are subject to swap reporting under Part 45.

– Real-time reporting requirements will apply to foreign exchange derivatives, though FX forwards and FX swaps will not be subject to real-time reporting if the Department of the Treasury’s proposed and partial exemption of these products becomes final; FX forwards and FX swaps will, however, be subject to the Part 45 Recordkeeping and Reporting requirements.

Part 46 Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps

– Part 46 requires recordkeeping and reporting for swaps that are deemed “pre-enactment” or “transition swaps”. As with the rules above, most end users will not be responsible for reporting requirements, so long as they transact only with “swap dealers” (“SDs”) and “major swap participants” (“MSPs”). Only end users that either transact with other end users or have affiliated entities that transact with one another will have to report data to swap data repositories (“SDRs”).

– The final rule states Pre-enactment swaps include “any swap entered into prior to enactment of the Dodd-Frank Act of 2010 (July 21, 2010), the terms of which have not expired as of the date of enactment of that Act.”

– Transition swaps are defined in the final rule to include “any swap entered into on or after the enactment of the Dodd-Frank Act of 2010 (July 21, 2010) and prior to the applicable compliance date on which a registered entity or swap counterparty subject to the jurisdiction of the Commission.”

Overview of Reporting and Recordkeeping

The Foreign Account Tax Compliance Act (FATCA)

The Foreign Account Tax Compliance Act (FATCA) goes into effect January 1, 2013, and may have an adverse tax impact on certain payments made in derivative transactions.

End-User Exception Election

For swaps subject to mandatory clearing, end users will be exempt if they qualify for the end user exception and provide justification. The end user exception must be elected on a per trade basis.

  • If an end user is facing a swap dealer, the exempt end user would provide the information to its swap dealer counterparty, or its financial entity counterparty. The dealer or financial entity would report this information to a “swap data repository” along with the specific trade details.
  • If two end users face each other, one of the end users would have to notify the CFTC, through reporting to the SDR, that the election to use the end-user exception to mandatory clearing.
  • The CFTC’s final rule would require any end user that wishes to be exempt from clearing to report additional information on an at-least annual basis. The information required to be reported includes:
  1. Basic legal entity information
  2. Whether the entity is hedging commercial risk
  3. Whether the end user posts margin or otherwise secured some or all of the swap exposure (e.g., through “cross-collateralization”)
  4. Whether a financial affiliate is acting as an agent and entering into the hedge on behalf of a non-financial end user
  5. If public (i.e., an “SEC filer”), the firm’s central index key
  6. If public, evidence of “board” approval

Impact on Non-Financial End Users

Private Funds: Regulations Relevant to the Financial Entity Definition

In order to determine whether and how these requirements apply to an end user, the end user must determine whether or not it is a “financial entity” under the Dodd-Frank Act.

Private Funds: Regulations Relevant to the Financial Entity Definition

Guide to Eligible Contract Participant Definition

After October 12, 2012, only Eligible Contract Participants (“ECPs”) are permitted by law to enter into OTC derivatives transactions. Non-ECPs will no longer be able to use the line of business exemption. Eligible Contract Participants generally include:

  • Entities with $10 million in total assets
  • Entities with a guarantor that is an entity with $10 million in assets
  • Entities with a net worth of at least $1 million and are hedging
  • Individuals with “amounts invested on a discretionary basis” that exceed $10 million, or $5 million if hedging

If an entity by itself does not qualify as an ECP, it may nonetheless qualify IF all of the following conditions are met:

  • it must be entering into a swap (i.e., an interest rate, FX or commodity derivative and not a credit or equity derivative);
  • it must be using the swap for hedging commercial risk;
  • all of its owners must qualify as ECPs; and
  • the entity and its owners in aggregate must have $1mm in net worth

Guide to Eligible Contract Participant Definition