Entries for ' regulation'

Recent buzz around the Commodity Futures Trading Commission (CFTC) has less to do with derivatives and more to do with departures. Bart Chilton is the latest member to announce his intent to resign, and come January, three out of five seats on the commission will be vacant. Mark Wetjen and Scott O’Malia are expected to remain once the dust settles, but their opposing views are likely to put all decisions on hold until Obama's nominee, Timothy Massad, gets confirmed in the Senate, and that could take months.

Regardless of who ultimately ends up running the agency, the road to compliance will not get any easier. Commissioner O’Malia recently acknowledged this sentiment: “…the intent of the Dodd-Frank Act was not to place excessive and unnecessary new regulatory burdens on end-users.” Unfortunately, participants in affected markets know that compliance regulations have gotten more complex since the legislation came to be, and in some cases CFTC developments have threatened profits. Several major players have decided to exit the market completely instead of create new trading strategies.

It doesn’t have to end this way. Triple Point Technology’s commodity trading and risk management (CTRM) enterprise software helps our clients make intelligent trading decision while promoting compliance. Commodity XL for Dodd Frank supports real-time position management, captures CFTC reportable data elements, and connects with swap data repositories. Triple Point also employs dedicated staff to stay ahead of market and regulatory demands so that your company can focus on mitigating risk and driving profits. Read more about Commodity XL for Dodd Frank and Triple Point’s other regulatory software solutions.

Map of CongoIn our circles, when we talk about the Dodd-Frank Act, we tend to gravitate our conversations to Title VII – Wall Street Transparency & Accountability.  It is, of course, the most hotly disputed, high profile part of the legislation.   So, it’s easy to forget some of the other sections of DFA that may concern corporations.  One such section is 1502.

Section 1502 – Conflict Minerals

This section requires a disclosure that on the surface seems fairly well intended.  Since Congress has determined that “the exploitation and trade of conflict minerals originating in the Democratic Republic of the Congo and adjoining countries is helping to finance conflict characterized by extreme levels of violence in the eastern Democratic Republic of the Congo, particularly sexual- and gender-based violence, and contributing to an emergency humanitarian situation”, corporations will be required to disclose their sources of “Conflict Minerals”.  Conflict Minerals include columbite-tantalite (coltan, niobium, and tantalum), cassiterite (tin), gold and wolframite (tungsten) and their derivatives. The State Department can add new minerals when they determine it is necessary.

Who will be impacted?

The impact will be broad, and will encompass all publicly traded companies that source the listed minerals. If you think about it, that covers quite a cross-section of industries: automotive, communications, electronics – you name it. By the SEC’s own estimates, at least 6,000 companies will be impacted. They will be required to disclose in their 10-K, 20-F and 40-F filings the use of “Conflict Minerals” in their products. Even if the source of the material cannot be established, that will also require disclosure. Lacking a de minimis provision in the law, any sourced quantity will necessitate disclosure.  The law also calls for due diligence, although that has not been entirely defined. In all likelihood the model of due diligence proposed by Organization for Economic Co-operation and Development (OECD), would serve as a template.

Court of Public Opinion

There are problems with distilling the complex problems of the Democratic Republic of the Congo to a sourcing disclosure and expecting it to be the solution.  There are legitimate tribal mining operations that are likely to suffer as a result of this requirement.  Regions of the DRC are not in conflict, but they are already witnessing the impact of the proposed rulemaking. According to a recent New York Times article, many mining operations in Eastern Congo have been damped or halted completely. And so the SEC struggles – delaying its final rulemaking yet again. With no established SEC guidelines, I would anticipate more mining operations to close. The concern among manufacturers is also heightened, and it is not just a cost of compliance issue. The fear is that the public’s perception will drive investment or product purchase decisions based solely on a DRC tag or a lack of traceability.  Keep in mind, the legislation does not make it illegal to source Conflict Minerals, it just requires the disclosure of that information. I’m all for doing the right thing here, but I’m just not entirely convinced that this is the right thing. Not for the people of the DRC or the corporate world.

EU-FlagThe 2,000 page Dodd-Frank Act is the US government’s response to the financial crisis. While it was signed into law well over a year ago, the finer points are still being negotiated, clarified by lawyers, and challenged by Wall Street players.

For energy and commodity firms operating in Europe, this is a cautionary tale – the European Union (EU) is introducing an alphabet soup of directives and legislation affecting the financial and commodity markets including the Regulation of Energy Market Integrity and Transparency (REMIT), the Market Abuse Directive (MAD), the second Market in Financial Instruments Directive (MiFID II), the European Market Infrastructure Regulation (EMIR), and the Capital Requirements Directive (CRD).

The EU’s objective is to have all legislation in force by the end of 2013. The exact provisions aren’t fully baked, but it’s clear that all companies trading over-the-counter derivatives will be impacted across the whole value chain from front office sales through to back office reporting and all points in between.

Not sure how to prepare your company for the impending regulatory avalanche? Mike Zadoroznyj, Triple Point’s Vice President, Treasury and Regulatory Compliance, has written an article for FX-MM magazine about what you need to do in order to ensure that your systems are compliant. Read it now

Out of all the changes put forth in IFRS 9 with regard to Hedge Accounting, one that will likely be well received will be the ability to hedge the risk components of non-financial items.  This is big news to many companies out there, in particular the foods industry and airlines.  Under IAS 39 and current FASB rules, they are not allowed to isolate the risk associated with a component of the risk being hedged.  For instance a company that produces baked goods must hedge the overall cost of flour and cannot simply isolate the cost of the wheat component to qualify for hedge accounting. Likewise, an airline cannot hedge crude oil as a component of it forecasted jet fuel requirement.

The current standard requires that the entity compare the entire change in value of the hedged item with the change in the value of the hedging contract to prove effectiveness.  Due to changes in other variable costs, such as milling costs in the case of flour, or refining margin, in the case of jet fuel, derivative contracts may not always correlate well.

Certainly, the economic aspects are intact regardless of whether or not the hedge actually qualifies for hedge accounting under the accounting standards. The consequences would be undesirable income volatility, since the gains or losses of unqualified derivatives must be taken into income immediately and would not match up with the actual timing of the risk being hedged. 

An important precept in IFRS 9 regarding component risk is that there is no need for a component to be contractually specified in order to be eligible for hedge accounting.  This should not be interpreted as an anything goes clause.  IFRS 9 guidance states that the component risk, when not contractually specified, must be “separately identifiable and reliably measurable”.  This will certainly be easier for some markets than others.  When the component risk isn’t clearly spelled out in a contractual specification, it may be require a bit of effort in determining the influence of individual components to price of the end product. 

As was the case under IAS-39, proper documentation is essential to qualify for hedge accounting.  From a hedge documentation perspective, you will need to clearly identify your risk if you are electing to hedge a component.  You will need to also state your method of assessing hedge effectiveness as well as your anticipated level of effectiveness.  Since IFRS 9 now allows the rebalancing of hedges, it will be necessary to fully document any hedging relationship changes on an ongoing basis.

 For many companies, where the economics and value of hedging have always been apparent, adopting IFRS 9 may now allow them to finally achieve the accounting benefits.

Now if only we can get to the long awaited convergence of IFRS and US GAAP, wouldn't that be nice?

For more information about hedging the risk components of non-financial items, see Ernst & Young’s Hedge accounting under IFRS 9 Guide (pages 8-10).

 

After four long years of debate, the CFTC has finally decided to impose position limits on commodity traders in an effort to curtail speculative trading.  The new limits will cover 28 commodities. What does it mean and how will it affect the markets? Ed Meir, an analyst at MF Global, says that it won't have much effect in the short term, but speculates that costs are going to rise for the end-user in the long term.  

If you're looking for a short summary on the new ruling, I highly recommend you watch the video below with Meir.  He does an excellent job of explaining who the new limits are going to impact and has some interesting thoughts on what the CFTC did wrong and why the ruling baffles him. 

Whether you work in the front, middle or back office of a company that trades derivatives, life will be changing for you in a big way. Well, that may be a bit dramatic, but really, your current work-flow will certainly be changing. To what degree largely depends on how your company gets branded – swap dealer, major swap participant or end user.   

Trading

Regardless of your company’s Dodd-Frank branding, its approach to derivative trading will most certainly be impacted. Your business processes may need to be adapted to keep records throughout a swap’s existence and for five years following final termination or expiration of the swap. In addition all swap data must be readily accessible throughout the life of a swap and for two years following its final termination. Daily trading records for swaps must be identifiable by counter party. The CFTC has the authority to request ad-hoc reporting from an entity. Your systems will need to support such requests.

If your company happens to fall into the category of swap dealer or major swap participant, you will likely be faced with additional trading room challenges. Your entire transaction history is to be tracked – from the moment of initiation onward.  All of the correspondence related to transaction activity – phone, email, text messaging – is subject to examination at the CFTC’s request. Swap dealers and major swap participants also must maintain a “complete audit trail for conducting comprehensive and accurate trade reconstructions.”[1]

The real-time reporting requirement will no doubt spawn the need to capture information that would not typically be captured in smaller trading operations. Don’t count on the on a status of end-user to exempt you from these requirements. Even if you qualify for end-user exception, depending on your counter party, you’ll need to assert who in fact will ultimately be responsible for reporting the transaction to a swap data repository (SDR).

Risk and Credit

Since the CFTC introduces two tests of substantial position as a daily requirement, you can bet that your risk and credit department will be busy. The first test of substantial position is based on an entity’s current uncollateralized exposure, and the CFTC’s proposed rule sets the threshold at a daily average of $1bn for credit, equity, or commodity swaps, and $3bn for interest rate swaps. The second test is based on an entity’s (PFE) potential future exposure, and is set at a daily average of $2bn for credit, equity, or commodity swaps, and $6bn for interest rate swaps. Moving beyond the thresholds dictated by these tests can push your company into being categorized as an MSP within a particular swap category.  It is important to note that the substantial position tests exclude those trades that are used for hedging or mitigating commercial risk.

In addition, your risk and credit groups will need to prepare a substantial counterparty exposure test.  This test raises the thresholds for current uncollateralized exposure and potential future exposure to $5bn and $8bn, respectively, without any exclusion for positions held for hedging or mitigating commercial risk.

Since the requirement is that all swaps that can be cleared must be cleared, unless exempted, margining becomes a concern. The credit group will need to carefully assess and project margin requirements.  Liquidity management, as important as it has been in the past, will now take on a role in the spotlight.

Hedging

Your hedge accounting group will need to maintain accurate records to substantiate your company’s hedging program.  This will be important if you wish to establish an end user exception for these transactions.  Business processes must assure that the proper documentation and tracking of hedging activity is in place from intent to inception.

Coordination

In a Dodd-Frank world, a successful implementation of compliance depends on an escalated level of communication and coordination between the various groups and systems within an organization.  You must consider it an enterprise deployment – trading, legal, risk, credit, finance, and IT – all must be part of the process and the solution.  Only by evaluating the implications of Dodd-Frank across all these areas will you be able to develop solid compliance plans. 

Although, the rules are still in the making, it’s never too early to start planning and assessing your potential problem areas.  



[1] Commodities Exchange Act – Section 4s(g)(4)



So, here we are, one year later, and still trying to get our collective heads around the complexity introduced by the Dodd-Frank Act.  So, how’s progress? Well, let’s take a quick look at the numbers.  As of July 27th, the CFTC had finalized 11 out of the 47 rules required, only 23% of the way there.  The SEC is fairing at about the same rate of finalization.  Now it is important to note that we’re primarily talking about Title VII of the DFA; other sections of the law haven’t had a stellar rule adoption rate either. This raises the question, “Shouldn’t more of the key moving parts be in place by now?”   


What Is Taking So Long, Anyway?

We’ve recently seen a level of Washington partisanship push us near to default status on our debt, so it should come as no surprise that legislation like the Dodd-Frank Act would inspire a predominantly divisive environment.  There are many bills that were recently introduced in Congress that hope to redact sections of DFA, not to mention the budget cuts that are planned for the regulatory bodies.  More with less seems to be the Congressional mantra.

To add to the legislative distress, President Obama is having a difficult time getting a new director to head up the Consumer Financial Protection Bureau. In mid July, he nominated former Ohio Attorney General Richard Cordray to the post. This nomination came when it was clear that Elizabeth Warren, the bureau’s acting director, was not going to get Senate approval to a permanent post.  Senate Republicans are not likely to back Mr. Cordray’s nomination either.  In fact, they don’t even want a director at all. They would rather have the bureau headed by a bipartisan five-member board.  Without a director, the CFPB cannot enact any rules.

If you caught the Daily Show on Comedy Central last week, there was a segment spoofing the Schoolhouse Rock cartoon “I’m Just a Bill”, where John Oliver portrays a very battered Dodd-Frank Bill.  Yeah, it’s funny, but sadly, it does illustrate some of the real problems that DFA faces, and quite possibly why we are witnessing such a slow rollout.

Hurry Up and Wait

With the CFTC and SEC both acknowledging the need to extend some deadlines along with their power to do so, it is apparent that we won’t see significant OTC regulation until the year end. We will also see much of the implementation moving in through calendar year 2012.  CFTC Chairman Gary Gensler has stated on more than one occasion that it is important to get this right. Overall, I believe, that the CFTC has made reasonable attempts to acquire industry guidance and input throughout the rulemaking process.  Perhaps this is a major contributing factor for some of the delays. I do, however, question the order in which the rules were proposed. I would have thought that the regulators would have tackled the bulk of the definitions first, but that’s just my view.

So, Happy First Birthday, DFA!

(What do you get a one-year old that needs everything?)

 

House of Representatives Bill, H.R. 87, introduced by Rep. Michele Bachmann, R-Minn. back in January, called for the full repeal of the Dodd-Frank Act (DFA).  As one would expect a repeal to be worded, the bill’s text simply states, “The Dodd-Frank Wall Street Reform and Consumer Protection Act (Public Law 111–203) is repealed and the provisions of law amended by such Act are revived or restored as if such Act had not been enacted.”  

Oddly, even with Republican leadership in the House, the bill seemed to lack any serious momentum. There are, however, two nearly identical Senate bills, S. 712 and S. 746, introduced by Sen. Jim DeMint [R-SC] and Sen. Richard Shelby [R-AL], respectively, that have really started to gain support.  In fact both bills have the backing of the entire Republican Senate. But will it be enough?  Right now – not likely. Remember that in the Senate, the Republicans are still the Minority party – just ask Senate Minority Leader Mitch McConnell, whose title serves as a daily reminder.

Without winning over any Senate Democrats, neither bill will likely see the light of day. But, let’s just say they do indeed pick up some votes from the Democrats, and the bill passes - they still need to get it through the House.  This is fun! Ok, now let’s pretend that by some stroke of luck the bill squeaks past the House and now sits on the President’s desk. Come on - you know it’s veto time! There is absolutely no way that President Obama will let this go, and if you remember your civics lessons (Do they still teach that?), both Houses would need to pass it with a two-thirds majority to make it stick. Now, with that, we are stretching the boundaries of reality.

What's likely is Congress will not increase the CFTC’s and SEC’s budgets. In the current economic climate, that really shouldn’t be a surprise. In fact, Congress intends to slash the agencies' budgets (see my March 23rd article). This will effectively hamper rule making and regulatory oversight as CFTC Chairman Gary Gensler has pointed out while relentlessly pleading for more funding.

As I see it, the killing off of DFA is not going to happen. As the DFA deadlines draw near, we may see some amendments to the legislation. I believe that Congress will be receptive to revise disputed sections of the Act, but to a wholesale repeal – no way. 

So, for now, don’t go dumping any plans relating to compliance. Remember, a bill is just a bill, but right now, Dodd-Frank is law.

The sweeping Dodd-Frank Act changes in the US for market participant classification, clearing, and margining are being closely watched and emulated internationally.  The dangers/opportunities between national regulations, adoption, and timelines can be significant.

In September of last year, the European Commission proposed a framework to regulate OTC derivatives, central clearing counterparties, and trade repositories.  In December, the Commission also published a consultation paper on the Markets in Financial Instruments Directive (MiFID) to "improve the regulation, functioning and transparency of the financial and commodity markets to address excessive commodity price volatility."  In a joint statement from EU Commissioner, Michel Barnier and CFTC Chairman, Gary Gensler, Barnier stated, "It's essential --across the board on all financial regulation--that the United States and Europe move in parallel and that we don't create new space for regulatory arbitrage."

It still remains to be seen how significant the differences will evolve, and which countries and companies will be most affected or take the most advantage (China stands out as a likely recipient of business fleeing costly or time-consuming regulations.)  Below is a table with some of the key similarities/differences.  Also of note is that some of the regulations at the bottom that are US-centric may be applied to US-listed companies or those operating in the US (e.g. Canada.)

 Description

US

 EU

 Clearing

 Mandatory for standardised OTC contracts (unless end-user exempted)

 X

 X

 End-User 
 Exemption

 Hedging for non-financial entities

 X

 X

 Mandatory
 Reporting

 Uncleared swaps to SDR (US) or trade repository (EU)

 All

 Specified
 Threshold

 Volker Rule

 Prohibiting bank proprietary trading

 X

 

 Swap Push Out

 Banks to establish separate trading entity ("too big to fail")

 X

 

 Timeline

 Deadlines for most major provisions to be published

9/2011

 12/2012

 Policy 
 Fragmentation

 Regulatory bodies that are responsible for enforcement

 Many
 Agencies

 Many
 Countries

 Payment
 reporting

 Reporting on payments to non-US governments (provinces and municipalities)

 X

 

 Compensation 
 Limits

 Executive compensation drawbacks

 X

 

 Safety 
 Regulations

 Companies operating mines in the US

 X

 

 Whistleblower
 Recovery

 Up to 30% >$1M in damages

 X

 

 Conflict
 Minerals

 Independent review of minerals being conflict free (e.g. Congo)

 X

 

George Carlin once told a great story about how he "put a dollar in one of those change machines and nothing changed.”  Wouldn’t it be nice if we could control change.  In today’s volatile world we never know when to expect it, where it will come from or what it will bring ­- we just know it’s coming.

The Dodd-Frank Act, the most sweeping financial reform since the 1930’s, is coming and it will bring dramatic changes to the face of energy and commodity credit risk.  New rules on central clearing, position limits and margining have the potential to significantly increase the cost of hedging and reduce the availability of credit.  Many of the details are still uncertain, but the 5 simple rules below will help you prepare for the Dodd-Frank Act and other inevitable changes. 

  1. Internal Scoring.  Don’t rely solely on credit rating agencies.  Your own internal model can be more accurate.
  2. Monitoring.  Monitor your cash flow risk and exposure. Increasing capital requirements make it more important than ever to mitigate risk and seize opportunity.
  3. Margining.  Do not use spreadsheets for collateral management. Robust collateral management is now a necessity. If you have a significant number of counterparties, it is time to eliminate spreadsheets. With the proliferation of margining they are no longer adequate and cannot provide active and accurate cash management.
  4. Reporting.  Build flexible reporting infrastructure that prepares for today’s uncertain fiscal and regulatory environment.
  5. Analytics.  Perform liquidity analysis with analytics. Companies who understand the impact of capital and margin requirements on their liquidity will have a competitive advantage.

We can’t control change, but proactive companies with a flexible trading and risk infrastructure will be best prepared to avoid the pitfalls and take advantage of the new opportunities that come with change.  Is reporting cash exposure a piece of cake? Do you know without a doubt your IT systems will meet new regulations? Is your margining process working great for you?  If not, maybe now is the time for change.

Events

Procemin 10th International Mineral Processing Conference

October 15-18, 2013 | Chile

XXV Brazilian National Meeting of Mineral Treatment and Extractive Metallurgy (ENTMME)

October 20-24, 2013 | Brazil



Opinions expressed on this blog are those of its individual contributors, and do not necessarily reflect the views of Triple Point Technology, Inc.