By Anne Friberg
A pre-Christmas gift from the CFTC extended an ISDA Protocol compliance deadline, but companies need to get busy.
Companies got a bit of a reprieve at the end of year with a key Dodd-Frank rule, but they will find 2013 to be payback time. Here’s a look at what to expect in the year ahead.
PROTOCOL DEADLINE EXTENSION
Much to the relief of corporate practitioners in charge of ISDA compliance everywhere, on December 18, the CFTC delayed the implementation of the rules underlying the ISDA August DF Protocol until May 1, 2013.
As a result of the extension, corporates did not have to forego holiday festivities to complete the Protocol in order to be able to trade on or after January 1, 2013. In addition to the new May 1 deadline for the Protocol, the swap-trading documentation rule requiring companies without ISDAs to have ISDA-like documentation by January 1, 2013 has a new deadline of July 1, 2013. However, according to Marc Horwitz at DLA Piper, “reporting rules, also covered by the protocol, were not extended. Dealers therefore will request CICIs and perhaps other information in order to satisfy their reporting obligations.”
And according to Chatham Financial, the deadlines for getting the necessary legal entity identifiers, aka CICIs, via the Markit website are April 10 for entities executing new trades and May 1 for entities completing the Protocol with pre-existing trades (entities with pre-existing trades but not completing the Protocol need to get their CICIs by October 7). NeuGroup members report that some of their legal entities are already pre-populated in Markit’s database (sourced from publicly available information) so care should be taken not to create duplicate entities as it may be an administrative headache to remove the duplicates.
QUESTIONNAIRE AND ADHERENCE
The DF Protocol involves several steps and they all need to be complete for the process to be effectuated. With the adherence letter (signed and fee paid), you agree to adhere to the Protocol. DLA Piper’s Mr. Horwitz points out that “adhering parties are not bound by the protocol agreements with other adhering parties until both parties match by exchanging DF questionnaires.”
Chatham Financial’s Luke Zubrod notes that the questionnaire is used to collect information necessary for the dealer to categorize your entities and determine what set of regulations apply (e.g., are you a “financial entity,” for example?).
“Because the exact nature of the changes to your ISDA depend on your answers to these questions, the questionnaire is necessary in determining how your ISDA needs to change,” Mr. Zubrod observes.
BOARD RESPONSIBILITIES
In the preamble to the Final End User Exception (EUE) Rule, the CFTC clarified issues around board involvement in entities utilizing EUE for SEC-reporting entities. The board (BOD) may approve exemption from clearing either on a general basis or a transaction basis.
The CFTC expects the BOD to set appropriate policies governing use of swaps subject to EUE and to review those policies at least annually and 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). Without the EUE, mandatory clearing begins in August, which is closer than it appears; regularly scheduled board meetings are few and far between so the process should start now.
Derivatives can be a very touchy topic outside treasury, so the board involvement should begin immediately so actions can flow with the natural progression of scheduled board meetings between now and the summer. Avoid presenting this matter in an emergency meeting or special session. The key necessary steps include educating the board on their responsibilities surrounding the decision to elect end-user exception; select the appropriate board committee to formally review and approve that decision and amend its mandate; and draft and submit language for the board committee to approve.
Get a LEGAL OPINION
The classification of treasury centers/in-house banks and which types of inter-affiliate trades qualify for the exception, which don’t, and how margin and reporting requirements apply are complex and are further complicated by extraterritoriality concerns depending on their geographic location, and may be covered by regulations in other jurisdictions. Centralized treasury centers that are “predominantly financial in nature” are not eligible for the end-user exception, even if the affiliate for which it is hedging is a non-financial end-user. As far as in-house banks and inter-affiliate trades are concerned, if transaction management is centralized through the non-financial parent company, the market-facing trade is not required to be cleared.
Those who hedge on behalf of affiliates via a centralized entity should seek a legal opinion on whether they (1) will still qualify for the end-user exception; (2) will be subject to added reporting requirements as a financial entity; and (3) whether inter-affiliate trades will be subject to margin requirements. On the last point, it is still possible that the end-user exemption from clearing will not exempt corporates from Dodd-Frank or prudential bank regulators’ margining requirements.
INTER-AFFILIATE TRADES REPORTING
Inter-affiliate trades are not exempt from Dodd-Frank reporting requirements, so, where there is no external swap dealer involved, your treasury entity will be responsible to report the trade data to a swap data repository (SDR); this needs to begin on April 10, 2013.