coalition for derivatives end-users briefing of house committee on agriculture staff january 29,...
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Coalition for Derivatives End-UsersBriefing of House Committee on Agriculture Staff
January 29, 2013
<Presentation Title/Client Name>
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Coalition Comments on Proposed Rules• The Coalition for Derivatives End-Users has submitted comments on proposed rules:
– CFTC & SEC joint advance notice of proposed rulemaking on Definitions Contained in Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act
– Treasury request for comments on Determination of Foreign Exchange Swaps and Forwards
– CFTC proposed rule on Process for Review of Swaps for Mandatory Clearing
– CFTC advance notice of proposed rulemaking on Protection of Cleared Swaps Customers Before and After Commodity Broker Bankruptcies
– CFTC proposed rule on Real-Time Public Reporting of Swap Transaction Data
– CFTC proposed rule on Swap Data Recordkeeping and Reporting Requirements
– CFTC & SEC joint proposed rule on Further Entity Definitions
– CFTC proposed rule on End-User Exception to Mandatory Clearing of Swaps
– CFTC proposed rule on Core Principles and Other Requirements for Swap Execution Facilities
– CFTC proposed interpretive order on Antidisruptive Practices Authority
– CFTC proposed rule on Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps
– Prudential Regulators’ proposed rule on Margin and Capital Requirements for Covered Swap Entities
– CFTC proposed rule on Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
– CFTC & SEC joint proposed rule on Further Product Definition
– CFTC proposed rule on Clearing Exemption for Swaps Between Certain Affiliated Entities
– CFTC proposed interpretive guidance on Cross-Border Application of Certain Swaps Provisions of the CEA
– BCBS/IOSCO consultation on Margin Requirements for Uncleared Derivatives
– Prudential Regulators’ proposed rule on Advanced Approaches Risk-based Capital Rule; Market Risk Capital Rule
• Limited time to comment has limited the Coalition’s ability to comment on every rule proposal that affects end-users.
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New Derivatives Regulation under Title VII:Extraordinary Changes
Voice & Manual Systems Electronic Trading
Bilateral Risk Management Central Clearing
Execution
Clearing
Reporting
Swap Data RepositoriesLimited Transparency
Margin
Negotiated Margin Agreements Required Margin Collection
<Presentation Title/Client Name>
Overview of Swaps Market Under the Dodd-Frank Act
Background•A swap is the exchange of cash flows between counterparties.
– e.g., an interest rate swap (the most common type of swap) is an agreement between two parties to exchange interest rate cash flows (e.g., fixed rate for floating rate), calculated on a notional principal amount, at specified intervals (i.e., payment dates) during the life of the agreement.
– Asset classes include: interest rate, credit, equity, foreign exchange and other commodity.
•Title VII of the Dodd-Frank Act granted jurisdiction of the swaps market to the CFTC and the SEC, with the CFTC having jurisdiction over the vast majority of the swaps market.
•As a result of Title VII and the CFTC’s regulations, all swaps must be reported to swap data repositories (“SDRs”) and many swaps will be subject to clearing, execution and margin requirements.
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PARTY A PARTY B
Fixed Rate Payments (e.g., 5% fixed payment on $100 million)
Floating Rate Payments(e.g., 3-month LIBOR on $100 million)
<Presentation Title/Client Name>
Overview of Swaps Market Under the Dodd-Frank Act
Clearing
•When a swap is executed, the two counterparties can send the trade to the clearinghouse (through a clearing member) and the clearinghouse will assume the legal risk of making payments on the trade (essentially guaranteeing the payments to each of the counterparties).
•The swap counterparty is required to have an account with a “clearing member” firm and deposit margin in the account with the clearing member firm. The clearing member firm then interacts directly with the clearinghouse.
•The margin that must be required to clear a swap is required by clearing rules and not by margin rules.
•CFTC determines which swaps must be cleared. At this time, interest rate swaps and credit default index swaps are required to begin clearing in March 2013.
•Title VII explicitly provides an exception for end-users to the mandatory clearing requirements.
Execution
•Standardized swaps will be required to be executed on a swap execution facility (“SEF”) or a designated contract market, as opposed to traditional bilateral contracts.
•The CFTC has not yet finalized rules for SEFs or for which swaps are required to be executed on a trading platform.
•Title VII explicitly provides an exception for end-users to the mandatory execution requirements.
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<Presentation Title/Client Name>
Overview of Swaps Market Under the Dodd-Frank Act
Reporting
•All swaps, whether cleared or uncleared, must be reported to an SDR, including internal transactions related to the risk management activities within a particular company.
•Most swap data will be publicly disseminated (on an anonymous basis) for those that want to view or use the data.
Margin for Uncleared Swaps
•Title VII requires that swap dealers be required to collect margin (i.e., collateral) with respect to swaps with certain counterparties.
•Collecting margin on swaps is aimed at reducing systemic risk.
•Congress has communicated repeatedly both throughout the legislative process and in the text of the Dodd-Frank Act that end-users should not be subject to margin requirements.
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<Presentation Title/Client Name>
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AprOct2012
Nov Dec Jan2013
Feb Mar
• Definition of “swap” is effective• Becomes unlawful for ECPs to enter off-exchange swaps• Reporting and Recordkeeping rules become final
May Jun Jul Aug Sep Oct
• Treasury excludes FX from “swap” definition
• Swap Dealer Registration
• Some SD/SMP Reporting and Recordkeeping effective
Expected in first half of 2013:Trading, Execution and Block Trade Requirements
Cross-Border Guidance • Margin Requirements
• Obtain Unique Identifier Numbers• End-User Reporting and Recordkeeping
• Financial end-users must clear IR and credit default swaps
• Non-financial end-users must elect clearing exception
Implementation Timeline
• External business conduct standards
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How Do End-Users Use Swaps?
• End-users do not use derivatives to take on risk for speculative investment purposes and therefore do not meaningfully contribute to systemic risk.
• End-users use swaps to hedge or mitigate commercial risks associated with their companies’ operations.
• The use of swaps to hedge risk benefits the global economy by allowing a range of businesses – from manufacturing to health care to agriculture to technology – to improve their planning and forecasting and offer more stable prices to customers.
• Imposing undue regulatory burdens on end-users could increase costs and reduce liquidity that would prevent end-users from using the derivatives markets efficiently or may cause end-users to stop using derivatives altogether.
– Either result is contrary to the clear objectives of Congress who have created exemptions that would allow end-users to continue managing risks in the swaps markets effectively and efficiently.
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<Presentation Title/Client Name>
Centralized Hedging Units
• Creates scale and efficiency while reducing risk
• Centralizes expertise and consolidates execution
• Presents single/limited number of faces to the market
• End-user transaction platform
• Does not create or increase systemic risk
Centralized Model•ISDA contracts consolidated with one entity
•Netting permits a single exposure or credit with the bankruptcy estate
•Facilitates settlement and resolution
Streamlined resolution … less risk
Bank A
ABC CorpDeriv. Unit
ABC Corp US Affiliate
Bank
BBank
C
Traditional swaps »
Matched affiliate trades »
Enhances safety and efficiency for a broad range of end-users
ABC Corp US Affiliate
ABC Corp UK Affiliate
ABC Corp Asia Affiliate
Common control
De-centralized Model•All ISDA contract counterparties settle separately
•Some entities would owe the bankruptcy estate …others become unsecured creditors
•Netting not possible … multiple claims
More complicated … greater risk
Additional benefits arise in a default scenario
Treating inter-affiliate trades like external swaps would push firms back to a decentralized model … increasing risk.
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<Presentation Title/Client Name>
Centralized Hedging Units
• The Dodd-Frank statutory language limits to those centralized hedging units “acting on behalf of the person as an agent” which the CFTC has interpreted to not include swaps executed by centralized hedging units acting as principal.
– Such swaps between the centralized hedging unit (as principal) and a third party would not be eligible for the end-user exception because the centralized hedging unit is considered a “financial entity”
• Many end-users that use a centralized hedging unit model execute trades on a principal basis to:
– Reduce risk (i.e., fewer external transactions), reduce costs, reduce duplication, centralize oversight of swaps activities, enable netting
• Treating these two forms of execution differently can create a competitive disadvantage and would discourage end-users from using this proven risk mitigation technique.
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<Presentation Title/Client Name>
ABC Hedging Unit
Affiliate(Financial)
Centralized Hedging Unit Acting as Agent/Principal
ABC Corp.
(Nonfinancial)Bank
Market-facing swapsin name of ABC Corp.
(Hedging Unit as agent)
Hedging Unit can choose not to clear
swaps
ABC Corp.
(Nonfinancial)
ABC Hedging Unit
Affiliate(Financial)
Bank
Market-facing swapsin name of
ABC Derivatives Unit
(Hedging Unit as principal)
Hedging Unit must clear swaps
Internal, affiliate trades
Agent
Principal
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<Presentation Title/Client Name>
Inter-Affiliate Trades
Characteristics of Inter-Affiliate Trades• No change in beneficial ownership.
• Inter-affiliate transactions do not face the market.
• Reduces demands on an entity’s financial liquidity and operational assets.
• Inter-affiliate transactions do not create or increase systemic risk.
• Promotes efficiency in mitigating risk within an entity.
ABC Corp
Deriv. Unit
ABC Corp
Affiliate #1
ABC Corp
Affiliate #2
Bank
$250 MM Notional Floating Rate A
$250 MM Notional Fixed Rate B
$150 MM Notional Floating Rate A
$100 MM Notional Floating Rate A
$150 MM Notional Fixed Rate B
$100 MM Notional Fixed Rate B
ABC Corp. Inter-affiliate trades matched to market-facing swap
Market-facing, arm’s length swap
Common Control
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<Presentation Title/Client Name>
Relevant Dates for End-User Compliance
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Date Rule/Requirement Action
April 10, 2013 Reporting and Recordkeeping for all Swap Market Participants (including all end-users)
End-users must comply with all reporting and recordkeeping rules (including with respect to inter-affiliate swaps).
May 1, 2013 External Business Conduct Standard Requirements
End-users must amend existing swap documentation in order to continue to trade with swap dealers.
June 10, 2013 Mandatory Clearing for Financial Entities (including financial end-users and centralized hedging units)
Centralized hedging units operating on behalf of non-financial affiliates would be required to clear at this time.
Mid-2013 (expected) Margin for Uncleared Swaps Final rules from the Prudential Regulators and the CFTC that could impose margin requirements on end-users.
September 9, 2013 Mandatory Clearing for All Swap Market Participants (including non-financial end-users)
Non-financial end-users will be required to either elect the end-user exception or clear their swaps.
Companies and organizations that support various initiatives of the Coalition for Derivatives End-Users
3M
A&D Insight, LLC
Acadia Realty Trust
AES Corporation
Air Products and Chemicals, Inc.
Alcoa
Allegheny Energy
Allegheny Technologies Incorporated
Alliant Energy Corp.
Allstate Insurance Company
AMB Property Corporation
AMC Entertainment Inc.
Ameren Services
American Adhesive Coatings Company
American Electric Power
American Residential Communities
Anadarko Petroleum Corporation
Applied Materials, Inc.
ARAMARK Corporation
Archer Daniels Midland Company
Ashford Hospitality Trust
Associated Estates
Atmos Energy
Avista
Ball Corporation
Bayer Corporation
Black Diamond Minerals, LLC
Black Hills Corporation
Blyth, Inc.
Bobrick Washroom Equipment, Inc.
Bolton Emerson Americas
Boston Scientific Corporation
BP America
Cabot Corporation
Cargill, Inc.
Caribbean Property Group
Caterpillar Inc.
Chatham Financial
Chesapeake Energy Corporation
CIP Real Estate
CMS Energy
CNL Financial Group
Columbia Sussex Corporation
Conoco-Phillips
Community Health Systems
Compass Minerals
ConAgra Foods, Inc.
ConGlobal Industries
Constellation Energy
Cordillera Energy Partners III, LLC
Craton Capital Management, LLC
CSC
Cummins Inc.
Cybex International Inc.
Daimler
Dean Foods Company
Deere & Company
Devon Energy Corporation
Dominion
Donahue Schriber Realty Group L.P.
Douglas Emmett
Duke Energy
DuPont Company
DuPont Fabros Technology
Dynegy Inc.
Eagle Rock Energy Partners, L.P.
Eaton Corporation
Ecolab Inc.
Edison International
El Paso Corporation
Emdeon
Enbridge Energy Company, Inc.
EnCana Oil & Gas (USA) Inc.
Energy Future Holdings Corp.
Entertainment Properties Trust
EOG Resources, Inc.
Exelon Corporation
First Capitol Ag
FMC Corporation
Ford Motor Company
Forest City Enterprises, Inc.
Formation Capital
FPL Group
Gavilon, LLC
General Electric Company
General Mills
General Motors
GID Investment Advisers LLC
Glimcher Realty Trust
Golden Living
Goodrich Corporation
Hampshire Real Estate
HCA Inc.
HCR ManorCare
Health Care REIT, Inc.
Heritage Feeders, L.P.
Hersha Hospitality Trust
Hess Corporation
Hewlett-Packard Company
Honda
Honeywell
Host Hotels & Resorts, Inc.
Hyundai Capital America / Hyundai Motor Finance Company
IBM
Jungs Station Associates
Kansas City Power & Light Company
KBS Real Estate Investment Trust, Inc.
Kelly-Moore Paint Co., Inc.
Kerzner Istithmar Limited
Kilroy Realty Corporation
Legacy Partners Residential, Inc.
Lexmark International, Inc.
LINN Energy
Lockheed Martin
Loews Corporation
McDonald’s Corporation
Marlin Steel Wire Products, LLC
Medtronic, Inc.
Microsoft Corporation
Mid-America Apartment Communities, Inc.
MidAmerican Energy Holdings Company
MillerCoors
MVP Management Corporation
National Grid
National Gypsum Company
National Retail Properties, Inc.
Nationwide Insurance
Newfield Exploration Company
Nissan North America, Inc.
Novation Partners
Novelis Inc.
Ocean Properties LTD.
Occidental Petroleum Corp.
ONEOK, Inc.
Peabody Energy
PepsiCo, Inc.
Portland General Electric
Principal Financial Group
Prudential Financial, Inc.
Public Service Enterprise Group
Puget Sound Energy
Quadrangle Development Corporation
Questar Corporation
Regency Centers Corporation
Rolls-Royce North America
Ryder System, Inc.
Sealed Air Corporation
Shell Energy North America
Siemens
Simon Property Group
Simons Petroleum, Inc.
Southern Union Gas Services, Ltd.
Southwestern Energy Company
Sprinkle Financial Consultants LLC
St. Mary Land & Exploration Co.
Strategic Hotels & Resorts, Inc.
Superior Graphite Co.
Superior Woodcraft, Inc.
Swift Energy Company
Targa Resources, Inc.
Teradata Corporation
The AES Corporation
The Boeing Company
The Commonwealth Group
The Dow Chemical Company
The Durst Organization
The JBG Companies
The Procter & Gamble Company
The Timken Company
The Walt Disney Company
Thomas Properties Group, Inc.
Timberlane Village Associates
Time Warner
Toyota
UM Holdings Ltd
United Technologies Corporation
Vectra Management Group
Vermeer
Volvo
W. R. Grace
Walker Center Associates, LLC
Wal-Mart Stores, Inc.
Weingarten Realty Investors
Whirlpool
Whiting Petroleum Corporation
Xcel Energy
Xerox Corporation
Zilber Ltd
Zimmer, Inc.
Aerospace Industries Association of America, Inc.
Agricultural Retailers Association
American Forest & Paper Association
American Cotton Shippers’ Association
American Farm Bureau Federation
American Gas Association
American Petroleum Institute
American Soybean Association
Associated Industries of Massachusetts
Association for Finance Professionals
Business Roundtable
Commodity Markets Council
Edison Electric Institute
Financial Executives International
Independent Petroleum Association of America
Independent Petroleum Association of Mountain States
Mississippi Manufacturers Association
National Association of Corporate Treasurers
National Association of Manufacturers
National Association of Real Estate Investment Trusts
National Association of Wheat Growers
National Corn Growers Association
National Council of Farmer Cooperatives
National Grain & Feed Association
Natural Gas Supply Association
National Mining Association
Texas Independent Producers and Royalty Owners Association
Texas Oil & Gas Association
Texas Pipeline Association
The Information Technology Industry Council
The Real Estate Roundtable
U.S. Chamber of Commerce
Companies
Organizations