Last month I wrote about three pieces of legislation, one House bill and two Senate bills, crafted to repeal the Dodd-Frank Act (DFA). I went into an analysis of why the passage of these bills really weren’t that likely. Well, this time around it seems that House Republicans are trying a different tactic – delay. Bill HR 1573, sponsored by House Agriculture Committee Chairman Frank Lucas, R-OK, co-sponsored by House Financial Services Chairman Spencer Bachus, R-AL, targets to delay much of DFA’s Title VII, the highly contested derivatives section, until late 2012.
The truth of the matter is that this bill has just as much probability of passing into law as the bills calling for repeal – that probability being zero – due to many of the same reasons cited in my previous article. The broader reality is that Dodd-Frank has become a partisan issue, with the GOP defending HR 1573 as a necessary sanity check to prevent the implementation of hastily thought out rules, while the Democrats cite a delay bill as a Republican ploy to wait for a more favorable repeal environment, namely a Republican held Senate or Obama’s defeat in 2012.
The CFTC hasn’t been silent on this topic either. Chairman Gary Gensler stated that CFTC already possesses the authority to extend dates if necessary, so a law is not required. The CFTC already said it won’t get all the rules engaged by July 16, 2011, of course referring back to its lack of funding as the reason. In a surprising move last month, the agency extended the comment periods on all of their proposed rules, including previously closed comment periods. Essentially, all rule comment periods that were closed as of May 4, 2011 were extended to June 3, 2011. The CFTC also sought public comment on the order in which the agency should finalize the rules.
Trusting the CFTC’s stance that they already possess the power to extend and delay components of Title VII, why would anyone feel it necessary to draft delay legislation? The most compelling Republican argument from HR 1573 supporters has been that the proposed bill is not just about delaying the engagement of the regulator’s rules, but also about delaying some of DFA’s automatic or self-executing rules. These rules are embedded in the DFA and don’t depend on any regulatory body rulemaking, and there are plenty of them. These rules repeal sections of the Commodity Exchange Act and the Commodity Futures Modernization Act of 2000, which creates a kind of legal limbo for certain OTC contracts, and introduces a slew of documentation and registration requirements, expecting all entities to be in compliance within the sixty days after June 16th. All this in an environment where the infrastructure hasn’t fully developed past what many view as a straw man phase.
The CFTC is well aware of the potential issues surrounding these triggered rules, and CFTC Commissioner, Scott O’Malia stated in a Reuter’s interview this week, that they are “working on a document and a proposal right now that creates certain safe harbors for self executing rules, to delay them until the new rules are in place.”
Make sure you are all buckled in tight, because this is going to be one helluva ride.
Triple Point announced today the availability of Commodity XL for Dodd-Frank: End User Exemption™. The compliance solution is designed to ensure that organizations comply with Dodd-Frank rules for validating hedging programs in order to avoid central clearing and additional margin requirements.
Dodd-Frank will require that all OTC trades be centrally cleared but exempts companies that trade to mitigate their commercial risk. Commodity XL for Dodd-Frank: End User Exemption enables the exemption process for each hedge, allowing companies to protect their hedging programs and ensure that valuable working capital is retained.
Triple Point’s compliance solution manages the exemption process on a hedge by hedge basis. Key functionality of the product includes a complete audit trail of hedging activity, effectiveness testing, and automated documentation and disclosure management. Commodity XL for Dodd-Frank: End User Exemption will be continually updated as regulations evolve.
“The business impact of failing to get Dodd-Frank end-user exemptions for bona fide hedges starts with increased margining but ultimately ends with hedging programs becoming too expensive to maintain. This puts organizations at risk of an increasingly volatile market,” said Michel Zadoroznyj, VP, treasury and regulatory compliance, Triple Point. “There are better uses of capital than having it sit in margin accounts. To ensure exemptions, organizations need to have the right software solution in place.”
For the third year running, top analyst firm Gartner has named Triple Point as a ‘Leader’ in trading & risk management. Among Triple Point’s many core strengths, Gartner stated that Triple Point continues to offer the most comprehensive FASB compliance solutions.
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.
- Internal Scoring. Don’t rely solely on credit rating agencies. Your own internal model can be more accurate.
- Monitoring. Monitor your cash flow risk and exposure. Increasing capital requirements make it more important than ever to mitigate risk and seize opportunity.
- 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.
- Reporting. Build flexible reporting infrastructure that prepares for today’s uncertain fiscal and regulatory environment.
- 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.
Attempting to cope with the ambitious time lines demanded by the Dodd-Frank Act, the CFTC went into high gear in December by promulgating 10 new rules. That put their total to over 40 rules related to DFA in five-month time span. To put this into perspective, prior to Dodd-Frank, the CFTC’s rulemaking averaged to only a little over 5 per year. The merits and faults of the rapidity of the CFTC’s rulemaking process has been the subject of many debates, but under current law, the deadlines stand and must be met.
December Proposed Rule Highlights
I won’t go into each and every rule that was proposed in December, but rather would like to highlight a few that I would consider very important. No, I’m not trying to trivialize the others; I just believe there are a few that are really high on many watch lists.
The Players Defined
How an entity is categorized will ultimately determine their specific regulatory requirements. Although Title VII of the Dodd-Frank Act provided basic definitions for Swap Dealer, Major Swap Participant and Eligible Contract Participant, it charged the CFTC and SEC to further define these entities.
Are You a Dealer?
The Swap Dealer definition did not really stray from what the legislators proposed. The
- Swap dealers tend to accommodate demand for swaps from other parties;
- Swap dealers are generally available to enter into swaps to facilitate other parties’ interest in entering into swaps;
- Swap dealers tend not to request that other parties propose the terms of swaps; rather, they tend to enter into swaps on their own standard terms or on terms they arrange in response to other parties’ interest; and
- Swap dealers tend to be able to arrange customized terms for swaps upon request, or to create new types of swaps at their own initiative.
If you meet the criteria, you’ll be required to register as a swap dealer. The proposed rule will permit an application to be designated as a swap dealer with respect to only specified categories of swaps or activities. So, being a swap dealer in one category of swap does not mean you are considered a swap dealer in other categories.
Pertaining to the definition of a Swap Dealer, the CFTC also established a De Minimis exemption as instructed by the DFA. In order to avoid the Swap Dealer classification an entity must satisfy all the following conditions:
- 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 exceed $100 million.
- The aggregate effective notional amount of such swaps with “special entities” (like governments) 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 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.
CFTC Chairman Gary Gensler stated that it wasn’t the intent to capture end users in the definition of swap dealers and felt that was reflected in the commission’s definition. Commissioner Scott D O’Malia brought up concerns in the energy market and whether entities currently categorized as producer/merchants will fall into the swap dealer category as a result of the rulemaking. The Commission admitted to not possessing a clear understanding of the complexity of the physical energy markets. The Commission is seeking comment from the energy sector to gain an understanding of factors that could influence the swap dealer definition.