The Commodity Exchange Act, as amended by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), establishes a comprehensive new regulatory framework for derivative transactions defined as “swaps” under the Act. “Swaps” are broadly defined to include most foreign exchange, interest rate, oil and gas, metal and other commodity derivative products, subject to a number of exceptions. Most notably, the Dodd-Frank Act requires a swap: (i) to be cleared through a derivatives clearing organization, unless an exemption applies or the Commodities Futures Trading Commission (“CFTC”) does not require the swap to be cleared, (ii) to be reported to a swap data repository (“SDR”) or to the CFTC, and (iii) to be executed on a designated contract market or swap execution facility once such platforms are available.
Dodd-Frank Act rulemaking for derivatives regulation has been in process for more than three years, with 46 rules finalized to date and others pending. After a number of extensions of the effective dates of these rules, important deadlines are now approaching for end-users of derivatives.
Legal Entity Identifier
CFTC rules require all parties to swaps to obtain a legal entity identifier, currently known as a CFTC Interim Compliant Identifier (“CICI”). Beginning on April 10, 2013, all market participants must have a CICI and end-users should provide their CICI to their swap counterparties to enable their counterparties to comply with their reporting and other obligations under the Dodd-Frank Act. Any end-users of swaps without CICIs should obtain them as soon as possible. Each corporate subsidiary that enters into derivatives must register for its own CICI. Companies may obtain a CICI and verify their status through the CICI Utility website at www.ciciutility.org.
External Business Conduct Standards
The CFTC’s rules regarding external business conduct standards become applicable on May 1, 2013. Under these rules, swap dealers and major swap participants must obtain certain information in their dealings with end-users before they can enter into new swaps or amend existing swaps. For example, swap dealers and major swap participants must verify the regulatory status of each end-user, make certain determinations regarding the suitability of swaps for each end-user, and provide additional disclosures to each end-user.
The International Swaps and Derivatives Association, Inc. (ISDA) developed the August 2012 DF Protocol to help parties to swap transactions comply with the External Business Conduct Standards. Parties may amend or supplement their existing ISDA Master Agreements and other swap agreements with their swap dealers by adhering to this Protocol.
Reporting Requirements for Past and Future Derivatives Transactions
The Dodd-Frank Act requires most derivatives, whether cleared or uncleared, to be reported to a SDR.Data required to be reported includes information regarding the terms of the transaction, changes in the transaction and changes in the mark-to-market value of the transaction. Certain data must also be reported for certain historic derivative transactions entered into on or after the July 21, 2010 enactment of the Dodd-Frank Act. In many cases, end-users will not be required to report their transactions because their counterparties who register as “swap dealers” or “major swap participants,” as well as certain other financial entity counterparties, will have the reporting obligation. However, where there are two U.S. end-user counterparties to a transaction, they must agree on which will be the reporting party, and a derivative transaction with a non-U.S. person which is not registered with the CFTC must be reported by the U.S. counterparty.
The reporting obligations for reporting of new and historic derivative transactions by end-users who are reporting parties were effective on April 10, 2013. However, the CFTC issued a temporary order on April 9, 2013 extending these deadlines for non-financial reporting counterparties allowing reporting to occur by: (i) July 1, 2013 for interest rate and credit default derivatives, (ii) August 19, 2013 for foreign exchange, equities and other commodity derivatives, and (iii) October 31, 2013 for historic derivative transactions. The CFTC’s order also requires non-financial entities to backload data for transactions entered into after April 10, 2013. The requirements for reporting to an SDR are extensive and may require a month or more to set up accounts and test IT systems, so end-users who have reporting obligations should start planning for compliance well in advance of these extended deadlines.
End-User Exception to Mandatory Clearing Requirement
The Dodd-Frank Act includes an exception to the mandatory clearing and execution requirements (the “end-user exception”) to permit non-financial companies to continue using non-cleared swaps to hedge risks associated with their underlying business. The exception is only available to an end-user that (i) is not a “financial entity” as defined in the Dodd-Frank Act, (ii) is using the swap to hedge or mitigate commercial risk, and (iii) provides certain information to the CFTC or an SDR. If an end-user is an SEC reporting company, then it must report whether an “appropriate committee” of its board of directors has reviewed and approved the decision not to clear swaps in reliance on the end-user exception. Such decision must be reviewed and approved at least annually and more frequently if there is a change in hedging strategy.
End-users of swaps should be determining whether or not it makes sense to clear certain types of swaps in the future and, if not, taking the necessary steps to comply with the requirements of the end-user exception. The clearing requirements will be adopted by the CFTC in a series of orders for specific types of swaps. The first of these clearing orders, affecting certain interest rate and credit default swaps, is effective for non-financial end-users beginning on September 9, 2013. We recommend that all non-financial end-users be prepared to clear their swaps or otherwise satisfy the requirements of an applicable exception before such date. Additional clearing orders for other types of swaps may be issued this year, each with its own deadline for compliance.
ISDA developed the March 2013 DF Protocol to facilitate compliance with the end-user exemption and certain other CFTC regulations. Parties may amend or supplement their existing ISDA Master Agreements and other swap agreements with their swap dealers by adhering to this Protocol.