By Dwight Cass
Regulators have scores of Dodd-Frank implementation rules to complete by July. Luckily for treasury, they are prioritizing those relating to OTC derivatives.
With over a hundred rules yet to be written, the July deadline for finalizing enabling regulations for the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) is fast approaching. Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler acknowledged in a recent speech what observers have long suspected: the implementation process will stretch far beyond that date.
To push the process along, the CFTC and the Securities and Exchange Commission (SEC) have divided the pending rules into three groups, ranked by their importance. The first group to be finalized—this spring, if all goes as planned—will include the OTC derivatives rules defining market entities, especially the major swap participants.
This is particularly germane to corporates with trading operations such as Shell or Cargill, because these businesses will most likely be labeled major swap participants. But the companies want the derivatives used by their non-trading operations to hedge exposures to qualify for the exemption. (See “So Just Who is a Swap Player?” iTreasurer, February 19, 2011.)
And, germane to all corporates seeking indemnity from the OTC clearing rules, this first group “may include a final rule on end user exemption from clearing,” according to Mr. Gensler, speaking at the Futures Industry Association’s annual meeting in Boca Raton last month.
THE FIRST ROUND
According to CFTC Chairman Gary Gensler, the agency will seek to finalize the following rules this spring:
- A rule defining market entities—dealers versus major swap participants versus exempt hedgers; and associated swap dealer and major swap participant registration requirements;
- A final rule on end-user clearing exemption
- Two mandatory clearing process rules
- A large trader reporting rule
- Enforcement rules (i.e., whistle blower and similar measures)
- Fair credit reporting and consumer information privacy rules
- A rule removing references to credit rating agencies in government regulations
Source: March 16 speech before Futures Industry Association Annual Conference
Positive reception
The CFTC published its proposed draft end-user exemption rule on December 23. Judging from the comment letters, corporates were moderately positive about it. The rule would allow an exemption for derivatives transactions that qualify for hedge accounting under US GAAP, or those that can be proven to generally reduce a commercial enterprise’s risks.
Originally, the CFTC considered using the hedge accounting standard alone, which would have meant that companies that did not seek hedge accounting would not be exempt from Dodd-Frank clearing rules.
Much is being left to the discretion of the CFTC, which promises to ease into the new regime.
One problem, however, is that the commercial hedging rule does not exempt end users from margin requirements, if regulators should see fit to impose them. If they do, it could undo much of the benefit of obtaining the commercial exemption in the first place.
Much is being left to the discretion of the CFTC, which promises to ease into the new regime, both for the sake of the market and to try to better coordinate with European regulatory efforts. The commission also has emphasized that the new rules will only apply to transactions going forward.
DO YOU QUALIFY?
The CFTC’s commercial hedging exemption rule, put out for comment on December 23, applies to transactions by non-financial institutions that:
- Qualify as bona fide hedging under CEA rules;
- Qualify for hedging treatment under Financial Accounting Standards Board Accounting Standards Codification Topic 815, Derivatives and Hedging (formerly known as Statement No. 133); or
- Are economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise, where the risks arise in the ordinary course of business from:
— a potential change in the value of (i) assets that a person owns, produces, manufactures, processes, or merchandises, (ii) liabilities that a person incurs, or (iii) services that a person provides or purchases;
— a potential change in value related to any of the foregoing arising from foreign exchange rate movements; or
— a fluctuation in interest, currency, or foreign exchange rate exposures arising from a person’s assets or liabilities.
Source: CFTC Office of Public Affairs
Prospective approach
Speaking before the European Parliament in March, Mr. Gensler said, “Regardless of the eventual effective dates of the swaps rules, to provide regulatory certainty to the market, rules relating to mandatory clearing, real-time reporting, the trading requirement, margin and business conduct standards will apply only prospectively to those transactions that are executed after the rules go into effect.” Even so, the Dodd-Frank derivatives to-do list remains imposing.
According to the SEC, between April and July, 2011, regulators plan to:
- Propose rules defining key terms used in the Act with respect to products
- Adopt rules defining key terms used in the Act with respect to intermediaries
- Adopt anti-manipulation rules for security-based swaps
- Adopt rules on trade reporting, data elements, and real-time public reporting for security-based swaps
- Propose rules regarding the registration and regulation of security-based swap dealers and major security-based swap participants
- Adopt rules regarding conflicts of interest for clearing agencies, execution facilities, and exchanges involved in security-based swaps
- Adopt rules to retain existing treatment of beneficial ownership determinations related to security-based swaps
- Adopt rules regarding the registration and regulation of security-based swap data repositories
- Adopt rules regarding mandatory clearing of security-based swaps
- Adopt rules regarding the end-user exception to mandatory clearing of security-based swaps.
Evidence of regulators’ implementation flexibility will be welcome. But it would only solve part of treasury’s problems.
Unable to determine if or how much a corporate must invest to comply with Dodd-Frank until the rules are finalized, treasurers are unable to plan with confidence; many are taking a wait-and-see attitude.
That uncertainty is itself one of the substantial costs of regulatory reform.
Other Thorns
The OTC provisions of Dodd Frank are not the only ones likely to impact treasury, although many see them as having the most profound effect. Others examples of forthcoming rules that will most likely impact treasury include ratings reform and greater disclosure requirements. And unpleasant surprises can arise in a variety of ways.
It is difficult to tell how ratings reform will affect corporate access to the capital markets. But if the asset-backed markets’ seize-up when agencies refused to let their ratings get circulated is any gauge, it could have a noticeable effect.
Dodd-Frank makes rating agencies legally liable for their opining—no more “shortest editorial in the world” defense for them. They may become more combative and prone to changing ratings rapidly, to avoid post-Lehman (and post-Enron, for that matter) embarrassments. The result would be more headaches for treasury.
Changes to governance rules, such as to Section 13(d) of the ’34 Act, could also bring changes to treasury. Dodd-Frank mandates that the one-day accumulation of a company’s stock that would trigger the requirement that the purchase be disclosed be lowered from 10 percent to 5 percent. This would be a boon for corporates facing hostile activists, and is thus facing opposition from so-called turnaround specialists.
With massive legislative undertakings like Dodd-Frank, unintended consequences often come thick and fast. Treasury should try to identify these issues before the rules are implemented.
EMIR Delayed
Derivatives legislation in Europe, known as European Market Infrastructure Regulation or EMIR, is also running into delays.
On April 5 the European Parliament announced that the vote on the rules would be delayed to May 24 from the original April 20 date. Although no specific reason was given—The Wall Street Journal reported that it was to have further discussions—there have been reports that European regulators are also struggling with the FX derivatives component of the rules.
Also, some policy-makers want to widen the scope of the legislation to include listed derivatives. This is aimed at increasing competition among exchanges. which others—something entities like the Deutsche Borse are firmly against.
But even after a vote, implementation will take time. The EC and the European Council would then make a final decision, after which they will conduct further research on the rules’ impact.