On April 18, 2012, the CFTC and SEC adopted final rules [1] to further define the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” and “eligible contract participant.” [2] The rules initially establish the threshold for the de minimis exclusion from SD registration requirements at $8 billion for swaps connected with dealing activity effected in a 12-month period for CFTC-regulated swaps and all credit default swaps and $400 million for other SBS. [3] Importantly, the rules also exclude from the scope of dealing activity swaps between majority-owned affiliates. The Commission also excluded certain hedging activity from the SD registration analysis.

The Commissions generally declined to adopt exclusions from the definition of SD and MSP for categories of persons, including for sovereign wealth funds, agricultural cooperatives and employee benefit plans. Furthermore, the Commissions confirmed that absent a limited purpose designation, an SD registration applies to the entire legal entity and to all of such person’s swaps or SBS, whether or not such swaps or SBS are entered into in a dealing capacity. The final rules do not address the extraterritorial application of Title VII, including whether a limited designation would be available for a U.S. branch of a foreign bank or to separate U.S.-facing activities from non-U.S.-facing activities; instead, the Commissions stated that they will address such issues in future releases.

With the adoption of these rules, there remains one step – the issuance of final swap product definition rules – before the start of the countdown for swap dealer and MSP provisional registration. The swap entity definition rules will be effective 60 days after they are published in the Federal Register, which is expected to occur shortly. For further information regarding the CFTC’s expected compliance timetable, see the last section of this memorandum.

…continue reading: CFTC and SEC Adopt Final Definitions for Swap Participants

Users of commodity derivatives markets are now facing major changes under proposed European and US legislation. Stronger supervision of the commodity derivatives market is one of the key areas of the G20 regulatory reform agenda. In Europe, the European Commission is proposing to regulate the activities of a wider range of commodity derivatives traders through amendments to MiFID. End-users will become subject to mandatory clearing requirements for OTC derivative transactions above certain thresholds once the recently agreed EMIR proposal comes into force. For the first time, the wholesale energy market and the commodity spot market will become subject to the market abuse regime. In the US, the Dodd-Frank Wall Street Reform and Consumer Protection Act brings in a comprehensive reform of the OTC derivatives market. This publication gives an overview of the impact of the various recent European and US regulatory changes from the perspective of non-financial businesses involved in commodity derivatives trading.

Introduction

Various proposals have been introduced since the onset of the financial crisis to strengthen financial regulation across the full spectrum of financial services at international, EU and domestic levels. Previous client publications address many of these proposals. This publication draws together various threads of regulation in the context of their impact on commodity derivatives trading.

…continue reading: The Revised EU and US Regulatory Frameworks for Commodity Derivatives

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) added Section 2(a)(13)(A) to the Commodity Exchange Act (the “CEA”), which requires the Commodity Futures Trading Commission (the “CFTC” or the “Commission”) to prescribe rules concerning the real-time reporting of swap transaction and pricing data. These rules are intended to provide transparency and enhance price discovery for swap contracts while protecting liquidity in the market as well as counterparty anonymity. On December 20, 2011, the Commission adopted rules concerning the “Real-Time Public Reporting of Swap Transaction Data” (the “Real-Time Reporting Rules”). At that time, the Commission chose not to adopt the provisions proposed in connection with these rules that concerned the procedures for determining minimum block sizes. Less than fifty days after adopting the Real-Time Reporting Rules, the Commission has re-proposed rules concerning procedures to establish appropriate minimum block sizes for large notional off-facility swaps and block trades (the “Proposed Rules”). If a trade size of a swap is greater than the appropriate minimum block size, whether executed on- or off-facility, the swap transaction and pricing data is subject to a reporting time delay. The Proposed Rules would provide a means for separating swaps into categories within five asset classes (the interest rates, credit, foreign exchange, equity and other commodity asset classes). Further, the Proposed Rules would establish prescribed initial appropriate minimum block sizes as well as methods for determining post-initial minimum block sizes. If the trade size of a swap is greater than the appropriate minimum block size, the swap transaction and pricing data is subject to a reporting time delay. The minimum block sizes in the Proposed Rules will be important not only for reporting purposes, but also may determine the size of trades that can be traded off-facility. The Proposed Rules would replace the interim cap sizes adopted in the Real-Time Reporting Rules with initial cap sizes and methods for determining post-initial cap sizes. In the release accompanying the Proposed Rules (the “Proposing Release”), the Commission offers a number of alternatives for categorizing swaps in each asset class as well as alternatives to the method for determining the appropriate minimum block size and cap size; the Commission would consider adopting any of these alternatives as a final rule.

…continue reading: CFTC Proposes Block Size Rules for Swaps

On February 23, 2012, the Commodity Futures Trading Commission voted to adopt final rules that regulate the internal conduct of futures commission merchants, introducing brokers, swap dealers and major swap participants. These rules impose duties and restrictions on these categories of registered entities concerning internal conflicts of interest and recordkeeping. Swap dealers, major swap participants and futures commission merchants must also designate a chief compliance officer who is charged with establishing and enforcing policies and procedures reasonably designed to ensure compliance with the Commodity Exchange Act and the regulations promulgated thereunder. The four types of registered entities must erect firewalls between clearing personnel and trading business personnel as well as between research personnel and non-research personnel. The final rules relating to recordkeeping require swap dealers and major swap participants to keep sufficient records to show general and trade-specific compliance with the Commodity Exchange Act and its regulations. The Commodity Futures Trading Commission worked closely with commenters and other regulators in drafting these rules.

…continue reading: CFTC Adopts Internal Business Conduct Rules

Recent developments arising out of the Greek sovereign debt crisis have required the ISDA Determinations Committee to determine whether a “Credit Event” has occurred under credit default swaps (“CDS”) referencing Greek sovereign debt. The Determinations Committee concluded on 1 March 2012 that a Credit Event has not yet occurred. We explain below why this is the case.

Standard Sovereign CDS incorporates the 2003 ISDA Credit Derivatives Definitions (as amended). These definitions set out what will constitute Credit Events and the Determinations Committee will then decide (on request) whether a relevant Credit Event has occurred and, broadly, the market has agreed to live with the result.

The Credit Event in question is “Restructuring”. Many different things might constitute “Restructuring”, but those in play at the moment are: (1) reduction in principal or interest, and (2) change in ranking in priority of payment, causing Subordination. These must occur in a form that binds all holders of the relevant Obligation and must result from deterioration in creditworthiness or financial condition of the debtor.

…continue reading: Greek Restructuring: Why Isn’t It (Yet) a Credit Event?

European and US market participants are having to prepare for the introduction of OTC derivatives legislation and clearing reforms, despite continuing uncertainty about the exact nature of significant elements of the new rules. Given the ‘sea of change’ engulfing the sector it’s important to focus on the practical effects of new regulation from a clearing member or market participant perspective.

Mapping the ‘sea of change’

Before going into any detail on individual areas of concern, it is worth very briefly sketching out the regulatory framework. In the US, the mechanism for implementing OTC derivatives regulations and clearing reforms is contained in the Dodd-Frank Act, while in Europe, the main legislation is the European Market Infrastructure Regulation (EMIR – as below), supported by further reforms in the Markets in Financial Instruments Directive (MiFID) and the Capital Requirements Directive 4 (CRD4). These changes are in response to the financial crisis, which highlighted a lack of information on positions and exposures of individual firms in OTC derivatives. This issue was seen to have prevented regulators from getting a clear view of the inherent risks building up in the system. It was also judged to have impeded accurate assessment of the consequences of a default and, as described by a recent European Commission impact assessment, “helped fuel suspicion and uncertainty among market participants during a crisis”.

…continue reading: What’s Over the Horizon for OTC Derivatives?

On 11 October 2011, the Financial Stability Board (the “FSB”) published its second progress report (the “Report”) [1] and accompanying press release [2] on the implementation of reforms to the over-the-counter (“OTC”) derivatives market. This follows its initial progress report published on April 15, 2011, [3] in which it expressed concern regarding many jurisdictions’ likelihood of meeting the end of 2012 deadline set by the G-20 and warned that to achieve this target, jurisdictions needed to take “substantial, concrete steps” toward implementation urgently. The Report, which comes out merely one year before the end of 2012 deadline, contains a more detailed review of progress towards meeting the commitments reached at the G-20 Pittsburgh summit in September 2009, to be enforced by end of 2012, including:

• all standardised OTC derivative contracts will be traded on exchanges or electronic trading platforms and cleared through central counterparties, where appropriate;
• OTC derivative contracts will be reported to trade repositories (“TRs”); and
• non-centrally-cleared contracts will be subject to higher capital requirements.

…continue reading: Progress on International OTC Derivatives Reform

The Commodity Futures Trading Commission (“CFTC”) adopted interim and final rules on positions limits applicable to option, futures, swap and swaption contracts related to 28 agricultural, metal and energy commodity contracts (the “Final Rules”). The Final Rules impose position limits on a spot-month basis as well as on an all-month and any-month basis. Exemptions are provided from these limits, including a narrow set for bona fide hedging transactions. The Final Rules also exempt certain preexisting positions. Market participants are required to aggregate their interests in commodity contracts across accounts and positions that they control or own, subject to limited exemptions. In addition, the Final Rules impose position visibility requirements with respect to energy and metal contracts. The Final Rules result in radical changes to the CFTC’s long-established position limit regime by, inter alia, taking over responsibility for position limits from the exchanges, expanding limits to include swaps, narrowing exceptions and expanding aggregation requirements.

…continue reading: CFTC to Impose Position Limits on Some Commodity Derivatives

On 20 October 2011, the European Commission published its long-awaited legislative proposal to revise the Markets in Financial Instruments Directive (better known by its acronym MiFID). The proposal is divided into two parts, a Directive and a Regulation, both of which are expected to enter into force in 2013. Financial institutions and users of financial services will now need to prepare to negotiate a wider regulatory perimeter, which captures previously unregulated and more weakly regulated business areas. Pre-trade and post-trade transparency will apply to a broader scope of instruments. Firms should also be aware of the wider interventionist powers for EU and national regulators under contemplation.

Introduction

The original Markets in Financial Instruments Directive (“MiFID”) came into force almost four years ago, in November 2007. MiFID was intended to enhance investor protection, improve cross-border market access and promote competition in the financial markets across the EU. Although MiFID has arguably achieved some of these aims, it is widely considered that the regime requires updating to reflect the lessons of the financial crisis and developments in the markets. The terms of MiFID itself anticipate a review in any event. However, the financial crisis has undoubtedly led to a far more wide-ranging proposal than might otherwise have been expected.

…continue reading: A Changing Landscape: The MiFID II Legislative Proposal

On Tuesday, October 18, the U.S. Commodity Futures Trading Commission (CFTC) voted 3-2 to adopt final rules imposing speculative position limits on certain agricultural, metals and energy futures and swaps contracts, pursuant to Section 737 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The final rules have not yet been published. The following discussion is based on statements made by CFTC staff and commissioners at the October 18 meeting as well as the CFTC-issued fact sheet and Q&A about the final rules.

Opening Statements by Commissioners

At the meeting, Commissioners Scott O’Malia and Jill Sommers made statements opposing the final position limits rule for many reasons, including that the rule was contrary to the Commodity Exchange Act (CEA), as amended by Dodd-Frank. Commissioners O’Malia and Sommers voted against the rule. Commissioner Michael Dunn issued an opening statement noting that he did not believe imposing position limits would have any effect on prices and may actually increase price volatility as well as costs to hedgers, but that Congress had required the CFTC to impose position limits. Despite Commissioner Dunn’s conclusion that “position limits are, at best, a cure for a disease that does not exist or a placebo for one that does,” he voted in favor of the proposal. Commissioner Bart Chilton supported the final rule, emphasizing that although the rule would not please everyone, it would ensure more efficient and effective markets devoid of fraud, abuse and manipulation. Chairman Gary Gensler, who cast the final vote in favor of the proposal, asserted in his statement that Congress had directed the CFTC to impose position limits and narrow the bona fide hedge exemption.

…continue reading: Toward Final Position Limit Rules on Certain Derivatives