Rima Consulting Updates

11th July, 2012

Rima Consulting
Regulatory Alert 11th July, 2012

SEC & CFTC Final Swap rules: "A Race to put Banks plan into action"

During a meeting held on 10 July 2012, the U.S. Swaps Regulator approved a key definition that will start the clock ticking on a host of reforms for the overthe-counter (OTC) global swaps market. The Commodity Futures Trading Commission (CFTC) voted on the definition of a "swap", which activates a countdown on compliance requirements for other rules, such as "registration and reporting", for major swaps players to comply with the Dodd-Frank financial reform law and Protection Act (Dodd-Frank Act).
Background The Title VII of the Dodd-Frank Act entitled the Wall Street Transparency and Accountability Act ("Title VII") establishes a regulatory regime applicable to the OTC derivatives market by providing the Securities and Exchange Commission (SEC) and the CFTC with authority to oversee the derivatives market. Title VII provides that the CFTC will regulate "swaps", the SEC will regulate "security-based swaps" (SBSs), and together they will regulate "mixed swaps". Now that both agencies have adopted the final rules, they will become effective 60 days after the date of publication in the Federal Register (FR). Final Rule related to the further meaning of Swap The definition of "swaps" determines which products will face a multitude of rules mandated by the Dodd-Frank Act, which requires most swaps to be centrally cleared and traded on exchanges or swap execution facilities. The swaps definition shades closely to the one first proposed by regulators in April 20111 and contained in the Dodd Frank Act itself. Swaps include: Foreign exchange swaps and forwards; Foreign currency options; Commodity options; and Cross-currency swaps and Forward rate agreements. The CFTC clarified that foreign exchange swaps and forwards 2 would be considered to be swaps under the Dodd-Frank Act, subject to a decision by the US Treasury on whether or not to exempt them. The swap definition also includes a number of exemptions for certain insurance products and some consumer and commercial transactions such as life, property, and casualty insurance. In addition, interest rate caps on consumer mortgages and home heating oil agreements are also exempt. The final

Section 721 of Dodd-frank Act defines a Swap as any agreements, contracts, or transactions. Regardless of the Treasury's decision, forex swaps and forwards will be subject to reporting and business conduct standards.

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11th July, 2012

rule makes clear that the exemption for some insurance products is a "safe harbor 3", meaning those products not explicitly excluded could still avoid swaps regulation. The CFTC added a seven-part test for distinguishing swaps from commodity forwards; a contract to buy or sell a certain amount of a commodity at a particular point in the future. A race against the clock for swap dealers Many of the rules set in motion by the definition fall heavily on so-called "swap dealers4," mostly banks with more than US$8 billion in swap trades annually. Major Wall Street firms and banks dominate the derivatives market and have been widely expected to be captured in the swap dealer category: JPMorgan Chase & Co, Bank of America, Citigroup, HSBC and Goldman Sachs control 96 percent of cash and derivatives trading for commercial banks and trust companies as of 31 December 20115, according to the Office of the Comptroller of the Currency. Market players will have 60 days to register with the National Futures Association after the final definition is published by the FR. Banks will have to implement robust internal and external business conduct standards6, and begin reporting swaps to swap data warehouses. A compliance delay recently proposed by the CFTC could push back some of these reforms if the agency finalises it. Final Rule related to the End-User Exception to the Clearing Requirement for Swaps The CFTC voted unanimously to approve a proposed rule that frees up end-users of derivatives from the requirement that they transmit their trades through independent clearing houses. The so-called "end-user rule" will be widened to exempt small banks, credit unions, and cooperatives with up to US$10 billion in assets. Dodd-Frank directed the CFTC to consider exempting small banks at that threshold, but many banks had lobbied for higher asset levels such as US$50 billion, or a riskbased measurement. The agency estimates roughly 30,000 firms would qualify for the exemption. Proposed Rule related to Clearing Exemption for Certain Swaps entered into by Cooperatives The CFTC also unanimously approved a proposal to exempt cooperatives such as farm credit and credit unions from the clearing mandate. The exemption would apply so long as the swaps are designed to hedge risk arising from loans or other financial interactions with their members, who must be "end users".

Remark
Since 21 July 2012, the G14 banks have tried to anticipate the regulatory changes however this was not a trivial exercise. All these institutions have been proactive and focused on a "to do list" to be prepared to comply with the new regulatory challenges. Now it is time to put the plan into action!

The CFTC adopted as a safe harbor, an interim final rule that excludes swaps entered into for the purpose of hedging physical positions: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/msp_ecp_qa_final.pdf
4

The Dodd-Frank Act definitions of the terms ``swap dealer'' and ``security-based swap dealer'' focus on whether a person engages in particular types of activities involving swaps or security-based swaps.\8\ Persons that meet either of those definitions are subject to statutory requirements related to, among other things, registration, margin, capital and business conduct.\9\: http://www.cftc.gov/LawRegulation/FederalRegister/FinalRules/2012-10562 http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/defs_factsheet.pdf
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http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq411.pdf p11 http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/index.htm

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Rima Consulting Updates

11th July, 2012

About Rima Consulting Rima Consulting Limited ("RIMA") is a boutique, London based, Consultancy & Advisory firm specialised in Risk Management and Regulatory Risk & Compliance. With a team of experts, RIMA provides consulting, advisory and training services to international banks, building societies and other financial institutions. We provide our clients with specialist advice with respect to market, credit, operational, legal, liquidity and regulatory risk. Moreover, we have extensive global experience and industry recognition in the Financial Services, Risk Management and Finance Communities. As trusted business advisors, we work in partnership with our clients to deliver solutions aimed at mitigating current and potential risks to their organizations. We help our clients to prepare for the new regulatory challenges and to improve their risk management capabilities. Contacting RIMA This publication is provided by RIMA as a service to clients. Questions regarding the matters discussed in this publication may be directed to any of our consultants. If you have not received this publication directly from us, you may obtain a copy of any past or future related publications at info@rimaconsulting.com.

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