Dodd-Frank: Gather Your Legal Team

May 05, 2013

By Hilary Kabak and Anne Friberg

Determining how your company will be classified, selecting the appropriate board committee for the end-user exception and keeping ahead of Dodd-Frank is not for the faint of heart. 

In the next few months, long talked-about Dodd-Frank rules will kick in.And like the song, “It don’t come easy.” Company classifications, end-user exemptions, inter-affiliate trades and the recent no-action relief language—all will require just about all the resources the company can spare. Updates of one sort of another have been a part of virtually every US-based NeuGroup meeting. Here are some things we have learned.

Prepare for August

Experts say half of corporates are already compliant with the ISDA August 2012 Dodd-Frank Protocol requiring them to determine what kind of entity they are, along with other representations. The deadline to have a board-approved end-user exemption to use uncleared swaps is September 9, 2013, otherwise, mandatory clearing will begin on that date and will cover certain interest rate and credit derivatives. If you are only doing FX and commodity swaps, the September 9 deadline does not apply to you. Many companies are shooting for the September deadline nonetheless.

On a related point, Sam Peterson from Ernst & Young cautioned that the US Treasury’s FX exemption is not as broad as some might expect because the statute and the rules refer explicitly to FX forwards and FX swaps where the currencies are actually exchanged.

What if the practice is to roll positions forward or net cash settle? Is the fact that the original intent was to exchange currencies sufficient? If this activity constitutes a swap, then you can look to use the end-user exemption. If not a swap, then electing the end-user exemption is not necessary and the trades won’t need to be included in the calculation to determine whether you are a major swap participant (MSP). Regardless, this is one of many issues to put to your legal team.

Pick your Board Committee

Having determined what kind of entity they are, according to a survey of The NeuGroup’s FX Managers’ Peer Groups (FXMPG1&2), most companies have identified the appropriate board committee for approving the end-user exemption; and most have chosen audit.

The final rule allows the Board committee to approve the end-user exemption from clearing either on an annual basis or a transaction-by-transaction basis, and the CFTC expects it to set appropriate policies governing the use of swaps subject to end-user exemption (EUE). The Board is also expected to review the use of the end-user exemption more often if appropriate (e.g., if a “new hedging strategy” is implemented, a term that is vague or undefined in the rules but would constitute some departure from the strategy already approved by the BOD).

The Board will have to disclose annually to the CFTC:

1. Is the organization part of a financial entity, and if so, under which provision is it eligible for the end-user exemption?

2. How does the organization generally meet its financial obligations under uncleared swaps?

3. How is it hedging or mitigating commercial risk?

4. Is it an SEC filer? If so, then it must have board authorization for uncleared swaps.

end-user exemption Language

By the time of The NeuGroup’s two FX groups’ FX Summit in mid-March, only two members had submitted any language to their selected board committees for securing the end-user exemption. They shared some of the relevant wording:

  • Resolutions: the hedging policies and strategies of the Corporation, as presented to the Committee, are approved. The Corporation and its subsidiaries are hereby authorized to utilize the End User Exception established by §39.6 of the rules and regulations of the Commodity Exchange Act as amended from time to time, and accordingly, to enter into swap transactions that are exempted from the mandatory clearing and trade execution requirements under the Act, provided such swap transactions are consistent with the hedging policies and strategies approved by this Committee.
  • Defined swap transactions as: (a) economically appropriate to the reduction of risks. (b) qualified as bona fide hedges. (c) qualified for hedge accounting treatment. Noted that swaps are: not used for a purpose that is in the nature of speculation. Noted that The Board has reviewed and approved the decision to enter into swap transactions that are exempt from the clearing requirements of the CEA. Noted that The Board resolves that the Company will provide the information required to comply with the exception’s reporting requirement. Delegated future responsibility to the Finance Committee.

No action relief

On April 1, 2013, the CFTC published its final rule on the clearing exemption for certain inter-affiliate trades.

Essentially, there are two options for opting out of clearing for inter-affiliate trades: (1) Claim the end-user exemption for inter-affiliate trades. This is what the CFTC expects most corporates to do; and (2) If you don’t qualify for the end-user exemption, you may be able to use the inter-affiliate clearing exemption, subject to certain conditions, but additional documentation, risk management, and reporting requirements apply.

Then on April 5, 2013, the CFTC put out its letter granting in part requests for no-action relief for reporting requirements for inter-affiliate swaps. The letter stated that inter-affiliate trades are “used only for managing risk within a corporate group, and therefore do not increase overall systemic risk or warrant the same reporting requirements as external swaps.”

It should be noted also that some relief on inter-affiliate swaps has been granted regarding section 45 reporting: If the affiliate is wholly owned, then part 45 of the rules requiring the swaps to be reported does not apply. If the affiliate is only majority owned, however, reporting will be required, but only on a quarterly basis.

However, all external trades will still have to be reported. If the external counterparty is not a registered swap dealer or major swap participant or a financial entity that is a “US Person,” you will have to confirm that they will take on the responsibility of doing the reporting or you will have to do so yourself. In addition, the April 5 no-action letter states that any firm using the clearing exemption for inter-affiliate swaps—as opposed to those using the end-user exemption—are not privy to the relief from reporting requirements.

There was also good news for historical reporting. If you meet certain criteria, there’s no requirement to report historical inter-affiliate trades under Part 46, but you must keep your own records.

On April 9, 2013, the CFTC released a time-limited (i.e., not permanent) no-action with respect to reporting requirements for swaps between entities that are not swap dealers or major swap participants. As the universe of trades covered by the April 9 no-action includes end users’ inter-affiliate trades, encompasses and overlaps the April 5 no-action in part.

Generally, the April 9 no-action postponed until later in the summer and fall the deadlines for reporting of swaps between entities that are not swap dealers or MSPs. With respect to inter-affiliate trades, an end user would look to the relief provided in the April 5 no-action letter after these extended deadlines for reporting of trades between end users and the relief granted in the April 9 no-action letter have expired.

Now what?

Quoting one client’s perspective on Dodd-Frank implementation, Mr. Peterson noted that there is still a lot of “wet cement.” While the rules seem to be firming up at least domestically, significant confusion remains regarding cross-border trades, including trades with foreign entities that have not registered as swap dealers in the US There has also been a noticeable increase in attention to foreign derivatives regulations.

In Europe, the European Market Infrastructure Regulation (EMIR) could be kinder than Dodd-Frank to corporates that are only hedging according to that law’s definition, but once the non-hedge swap threshold is met, then all trades are subject to mandatory clearing requirements.

For now, make sure you have a good legal team ready to determine your status and compliance requirements, and stay tuned.

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