coalition for derivatives end-users briefing of house committee on agriculture staff january 29,...

Coalition for Derivatives End-UsersBriefing of House Committee on Agriculture Staff

January 29, 2013

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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


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)



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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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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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


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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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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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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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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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





ABC Corp. Inter-affiliate trades matched to market-facing swap

Market-facing, arm’s length swap

Common Control

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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

coalition for derivatives end-users briefing of house committee on agriculture staff january 29,...

Documents

proposed rules

forwards cftc

rule proposal

swap execution facilities

covered swap entities

uncleared swaps

margin requirements

review of swaps