112th Congress / Title VIICFTC

Implementation PhasePhase

Mike GillMike GillSenior Policy AdvisorCrowell & Moring LLP

Monday February 28 2011

Crowell & Moring, LLP

Monday, February 28, 2011

2010 Midterm Election Results2010 Midterm Election Results

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2010 Midterm Election Results2010 Midterm Election Results

» US House of Representatives – Majority Rules– Republican majority: 242-193

• Republicans won 63 seats (needed 39 for control)John Boehner (R OH) Speaker of the House• John Boehner (R-OH), Speaker of the House

• All new Committee and Subcommittee Chairmen, with new priorities, including increased oversight of p , g gthe Executive branch

• Republican caucus more conservative; Democratic lib l (h lf f “Bl D ” ti dcaucus more liberal (half of “Blue Dogs” retired or

lost seats)• GOP leadership concerned about mid-90s style p y

“overreaching”3

2010 Midterm Election Results2010 Midterm Election Results

» US Senate – Majority Rules . . . sometimes– Democrats maintain control (despite loss of 6 seats)– Breakdown of Senate in 112th Congress

53 Democrats (Including two Independents)• 53 Democrats (Including two Independents)• 47 Republicans• Harry Reid (D-NV) Majority LeaderHarry Reid (D NV), Majority Leader• Mitch McConnell (R-KY), Minority Leader• End Filibuster: 60 votes• Democrats need to defend 23 Senate seats;

Republicans only 10

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Election Results – Gridlock or Systemic M t th C t ?Move to the Center?

BothBoth.

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Issues for the 112th» Unfinished 111th Congressional Activity

– Federal Funding (other than Congressional “earmarking”)– Transportation legislation (Surface & Aviation)– Patent Reform– International Trade– Cap & Trade

» New Legislative Activity» New Legislative Activity– Farm Bill– Education Policy– Environment– Chemical Regulatory Reform– Energy Policy– Congressional Investigations*

D fi it R d ti– Deficit Reduction– Corporate and Other Tax Reform

» Oversight/Implementation– Health CareHealth Care– Financial Reform*

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Dodd-Frank Title VII: The BasicsDodd Frank Title VII: The Basics

» Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA)Protection Act (DFA)– Passed July 21, 2010– Amends the Commodity Exchange Act (“CEA”)

To reduce risk increase transparency and promote market– To reduce risk, increase transparency, and promote market integrity, by

• Registration and regulation of swap dealers and major swap participantsp p

• Clearing and execution requirements• Recordkeeping and real-time reporting• Enhanced CFTC rulemaking and enforcement authorityEnhanced CFTC rulemaking and enforcement authority

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What is a Swap?What is a Swap?

» A swap is an agreement, option, cap, floor, or contract or transaction that derives it value from a financialtransaction that derives it value from a financial, economic, or commercial interest or consequence– Based on interest rates, currencies, commodities, securities,

indices, credit default swaps, weather, metal, agricultural products, and emissions

But it is not: futures; forwards and spots; securities act transactions; options on foreign currencies; contracts with federal entities; specifically excluded foreign exchange swaps and forwards; and

CFERC regulated energy contractsAnd not transactions “intended to be physically settled.”

» Does a physical option meet the intent test?

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p y p

FERC and CFTC OverlapFERC and CFTC Overlap

» Some products may fall in either jurisdictionFERC St t j i di ti– FERC or State jurisdiction

• Under FERC tariff rate• Not cleared on a Designated Contract Market orNot cleared on a Designated Contract Market or

Swap Execution Facility• Traded on facility owned by RTO or ISO

FERC retains jurisdiction under section 222 of FPA• FERC retains jurisdiction under section 222 of FPA and section 4(A) of NGA

– CFTC• Contracts not traded on RTOs or ISOs• Can exempt contracts subject to FERC if in public

interestPrivileged and Confidential 9

interest

New Participants to RegisterNew Participants to Register

» Swap Dealer“one ho holds itself o t as a dealer in s aps makes a market– “one who holds itself out as a dealer in swaps, makes a market in swaps, regularly enters into swaps as an ordinary course of business for its own account, or is commonly known in the trade as a dealer or market maker in swaps ”as a dealer or market maker in swaps.

» Major Swap Participant– Anyone who is not a swap dealer and maintains a substantial

position (to be defined in regulations)– Or creates counterparty exposure that threatens systemic risk– And financial entities that are highly leveraged, not subject to g y g j

capital requirements, and maintain large exposures to swaps

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ParticipantsParticipants

» What it means to be a Swap Dealer or Major Swap ParticipantSwap Participant– New Requirements

• Registration with CFTC and SECg• Minimum capital and margin (initial and variation)• Business conduct standards

V ifi ti f li ibl t t ti i t• Verification of eligible contract participants• Disclosure of material risks and conflicts• Daily markDaily mark• Special entities• Reporting of swap transactions

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Proposed Rules Defining “Swap Dealer”Proposed Rules Defining Swap Dealer

» Definition of “Swap Dealer” closely follows d fi iti t t i D dd F k A tdefinition set out in Dodd-Frank Act– Holds itself out as a dealer in swaps,

Makes a market in swaps– Makes a market in swaps,– Regularly enters into swaps with counterparties as an

ordinary course of business for its own account, ory ,– Engages in activity causing itself to be commonly

known in the trade as a dealer or market maker in s apsswaps.

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Proposed Rules Defining “Swap Dealer”Proposed Rules Defining Swap Dealer

» De Minimis Exemption from Definition of Swap Dealer– Must meet all of the following conditions to be exempted– Must meet all of the following conditions to be exempted

• The aggregate effective notional amount, measured on a gross basis, of the swaps that the person enters into over the prior 12 months in connection with dealing activities must not p gexceed $100 million.

• The aggregate effective notional amount of such swaps with “special entities” (as defined in CEA Section 4s(h)(2)(c) to i l d t i t l d th titi ) thinclude certain governmental and other entities) over the prior 12 months must not exceed $25 million.

• The person must not enter into swaps as a dealer with more than 15 counterparties other than security-based swapthan 15 counterparties, other than security based swap dealers, over the prior 12 months.

• The person must not enter into more than 20 swaps as a dealer over the prior 12 months.p

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Proposed Rules Defining “Major Swap P ti i t”Participant”» A person need satisfy only one of the following

criteria to be a Major Swap Participant:criteria to be a Major Swap Participant:– A person that maintains a “substantial position” in any of

the major swap categories, excluding positions held for hedging or mitigating commercial risk and positions

i t i d b t i l b fit l f h d imaintained by certain employee benefit plans for hedging or mitigating risks in the operation of the plan.

– A person whose outstanding swaps create a substantial counterparty exposure that could have serious adversecounterparty exposure that could have serious adverse effects on the stability of the United States banking system or financial markets.

– Any “financial entity” that is highly leveraged relative to the y y g y gamount of capital such entity holds and that is not subject to capital requirements established by an appropriate Federal Banking agency and that maintains a substantial position in any of the major swap categoriesposition in any of the major swap categories.

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Proposed Rules Defining “Substantial P iti ”Position”» The Commission proposes using tests based on

bj ti i l it iobjective numerical criteria» Tests consider both current uncollateralized

d t ti l f texposure and potential future exposure.» A condition that satisfies either test would be a

Substantial PositionSubstantial Position» Swaps hedging commercial risk and those part

of employee benefit plan positions are excludedof employee benefit plan positions are excluded

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Proposed Rules Defining “Hedging or Miti ti C i l Ri k”Mitigating Commercial Risk”» The definition would encompass any swap position that

– Qualifies as bona fide hedging under CEA rules– Qualifies as bona fide hedging under CEA rules– Qualifies for hedging treatment under Financial Accounting

Standards Board Statement No. 133, or– Is economically appropriate to the reduction of risks in theIs economically appropriate to the reduction of risks in the

conduct and management of a commercial enterprise, where the risks arise in the ordinary course of business from:

• A potential change in the value of (1) assets that a person owns, produces, manufactures, processes, or merchandises, (2) liabilities that a person incurs, or (3) services that a person provides or purchases;

• A potential change in the value related to any of the• A potential change in the value related to any of the foregoing arising from foreign exchange rate movements, or

• A fluctuation in interest, currency, or foreign exchange rate exposures arising from a person’s assets or liabilitiesexposures arising from a person s assets or liabilities

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Proposed Rules Defining “Substantial C t t E ”Counterparty Exposure”» The proposed thresholds for substantial

t t tcounterparty exposure are a current uncollateralized exposure of $5 billion, or a sum of current uncollateralized exposure andof current uncollateralized exposure and potential future exposure of $8 billion, across the entirety of a person’s swap positions.y p p p

Privileged and Confidential 17

Proposed Rules Defining “Financial Entity” d “Hi hl L d”and “Highly Leveraged”

» Financial Entity– The Commission proposes to use the definition of

“financial entity” in the Dodd-Frank Act provision for an end-user exception from mandatory clearing inan end user exception from mandatory clearing in CEA Section 2(h)(7)

» Highly Leveraged– The Commission proposes two possible definitions—

either a ratio of total liabilities to equity, as determined in accordance with US GAAP of 8 to 1 or a ratio of 15in accordance with US GAAP of 8 to 1, or a ratio of 15 to 1 measured in the same way

Privileged and Confidential 18

Proposed Rule on Swap Data R dk i & R diRecordkeeping & Recording» Section 728

– Prescribes standards for swap data recordkeeping and reporting and applies to both registered entities and counterparties involved with swapsand counterparties involved with swaps

» Section 729– Requires that at least one counterparty to a swap q p y p

must report data concerning the swap to an SDR

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Swap Data Recording and Reporting R i tRequirements» Data Recordkeeping Requirements Under the

P d R l kiProposed Rulemaking– Records must be kept throughout the existence of a

swap and for five years following final termination orswap and for five years following final termination or expiration of the swap. The records must be readily accessible throughout the life of a swap and for two

f ll i it fi l t i tiyears following its final termination.

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Swap Data Recording and Reporting R i tRequirements» Data Reporting Requirements Under the

P d R l kiProposed Rulemaking– The rule calls for reporting of swap data from each of

two important stages of the existence of a swap: (1)two important stages of the existence of a swap: (1) the creation of the swap and (2) the continuation of the swap over its existence until its final termination or

i tiexpiration.– Registered entities and swap counterparties must

report required swap creation data electronically to anreport required swap creation data electronically to an SDR.

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Who Reports the creation of a swap?Who Reports the creation of a swap?

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Who Reports the Continuation Data?Who Reports the Continuation Data?

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Swap Data Recording and Reporting Requirements - New Identifiers for SwapsRequirements New Identifiers for Swaps

– Unique Counterparty Identifies (UCI) Th UCI ld id tif th l l tit th t i• The UCI would identify the legal entity that is a counterparty to a swap.

• CFTC prefers international standardCFTC prefers international standard– Unique Swap Identifier (USI)

• created and assigned at swap’s execution• used to identify that particular swap transaction

throughout its existence.U i P d t Id tifi (UPI)– Unique Product Identifier (UPI)

• would categorize swaps according to the underlying products referenced in them.underlying products referenced in them.

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Real-Time Public Reporting Proposed R l kiRulemaking» Timing of Execution of a Swap

– Execution occurs immediately following or simultaneous with the affirmation of the swap.

– Affirmation is when parties agree on the primary– Affirmation is when parties agree on the primary economic terms of a swap (but not necessarily all terms of the swap).

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Dodd-Frank Title VIICFTCCFTC

Implementation PhasePhase

Mike GillMike GillSenior Policy AdvisorCrowell & Moring LLP

Monday February 28 2011

Crowell & Moring, LLP

Monday, February 28, 2011