Last week the International Swaps and Derivatives Association, Inc. (ISDA) published a new protocol called the "ISDA August 2012 Dodd-Frank Protocol" (DF Protocol). This is the first in a series of protocols planned to assist compliance with certain rules governing derivatives markets that will soon commence under Title VII of the United States Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
What is the purpose of the DF Protocol?
The DF Protocol applies to all derivatives which are "non-security-based swaps" for the purposes of the Dodd Frank Act (swaps), including all non-exempt interest rate swaps, FX swaps, credit default swaps, total return swaps, interest rate and currency exchange options, commodities options and swaps, metal swaps and energy swaps.
Adherence to the DF Protocol facilitates industry compliance by swap dealers (SDs) and major swap participants (MSPs) with seven incoming rules finalised so far by the Commodity Futures Trading Commission (CFTC rules). The CFTC rules govern activity in the non-securities-based swaps markets in the following areas:
Business Conduct Standards for Swap Dealers and Major Swap Participants With Counterparties;
Large Trader Reporting for Physical Commodity Swaps;
Position Limits for Futures and Swaps;
Real-Time Public Reporting of Swap Transaction Data;
Swap Data Recordkeeping and Reporting Requirements;
Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants; and
Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps.
The DF Protocol allows parties to enter into an agreement to apply selected Dodd-Frank compliance provisions to their swaps trading relationship (including by supplementing the terms of existing ISDA and other agreements governing swaps) by adding notices, representations and covenants responsive to Dodd-Frank requirements that must be satisfied at or prior to the time that swap transactions are offered and executed.
How do parties adhere to the DF Protocol?
Parties adhere to the DF Protocol by paying a fee of US$500 and delivering an adherence letter together with a completed questionnaire, which streamlines information exchanges, disclosures and representations to be made by the adhering parties under the CFTC rules, such as the "know your counterparty" information requirements under the external business conduct standards.
To further streamline this process, ISDA together with Markit have launched a technology-based solution (called ISDA Amend) to automate questionnaire submission and the sharing of information and documents to the appropriate counterparties. If they choose to make use of the new online facilities, parties can generate an adherence letter online and complete the questionnaire at the ISDA Amend website.
At present there is no cut-off date for adherence to the DF Protocol, although ISDA has reserved the right to specify a cut-off date on 30 days' notice.
What other steps is ISDA taking?
ISDA has indicated that it is likely to publish additional protocols to provide for similar streamlined compliance as future rules are finalised under the Dodd-Frank Act. ISDA also expects to conduct similar reviews for documentation changes mandated by legislative developments in other countries and regions as these develop.
The US Securities Exchange Commission is yet to finalise equivalent rules in respect of securities-based swaps, and therefore the current DF Protocol does not apply to these derivatives.
Implications for Australia
Australian entities that find themselves within the extraterritorial reach of the Dodd-Frank Act may be required to register as SDs or MSPs. Entities in this position may find adherence to the DF Protocol a useful means of satisfying their Dodd-Frank compliance obligations.
Other Australian entities who are outside the extraterritorial reach of the Dodd-Frank Act, but nevertheless trade with SDs and MSPs, may wish to adhere to the DF Protocol in order to streamline their provision of the representations and disclosures that SDs and MSPs may require of them from time to time for their compliance with the CFTC rules.