Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The CFTC rulemaking whirlwind that was 2012 has come and gone, putting the agency’s comprehensive swap regulatory regime mostly in place. While many energy companies and other swaps end users found much to be happy about in the final rules adopted during 2012 (such as high de minimis levels and new exclusions with respect to swap dealer determinations, reporting obligations that in most instances fall on exchanges and swap dealers, and a district court’s rejection of the CFTC’s position limits rule), there are several important steps such companies should be taking during 2013 to ensure compliance with the new regime:

1. Identify your swap transactions and activities

This step is essential to determine what your company’s swap compliance obligations are and to make sure it has appropriate processes and controls in place for compliance. What type of swaps do you engage in? Who trades in them at your company? Who are your swap counterparties and how are they classified under Dodd-Frank? What are your volumes? Are some of your “forward contracts” at risk of actually being considered swaps? What sort of optionality do they contain? Do you engage in book-outs?

2. Confirm that you are not a swap dealer

The regulatory obligations imposed on swap dealers are substantial. Although the general threshold under the de minimis exception is quite high ($8 billion, phasing out to $3 billion, in gross notional amount of swaps over a 12-month period in connection with dealing activity), the threshold with respect to dealing with special entity counterparties (i.e., government bodies, pension plans, endowments) is considerably lower ($25 million in general; $800 million, plus notice requirement, with respect to utility special entities under temporary no-action relief).

3. Establish parameters and controls for your trading desks

Establish parameters and controls to prevent your transactional personnel from engaging in transactions that may subject you to regulatory obligations for which you are not prepared, or that may require pre-approval by a compliance manager or other flagging. What kinds of contracts can they trade in freely? What kind of contracts should they not trade in? What kind of transactions should they flag, before or after execution, for the attention of your compliance team?

4. Properly document your book-out transactions (back to October 12, 2012)

If your transactional personnel book out forward contracts over the phone (or maybe even IM), you should have processes in place to ensure such book-outs are properly documented. Under an interpretation in the CFTC’s final swap definition rule, effective October 12, 2012, oral book-outs must be followed in a commercially reasonable timeframe by a confirmation in written or electronic form. Not doing so creates risk that the transactions may be viewed as swaps, and thus be subject to the reporting and other compliance obligations applicable to swaps.

5. Prepare for swap reporting obligations (April 10, 2013)

All swaps must be reported to a swap data repository under the Dodd-Frank Act. However, end users, if trading with swap dealer counterparties or in on-exchange, cleared swaps, can generally avoid swap reporting obligations. Nonetheless, all end users trading in swaps will need to obtain a legal entity identifier (LEI) for reporting purposes, most by April 10, 2013, and should have processes and controls in place to ensure that they are not required to report swaps or are able to report them correctly and in a timely manner if they are a “reporting counterparty” with respect to any swaps.

6. Prepare for swap recordkeeping obligations (April 10, 2013)

All swap counterparties and swaps are subject to the CFTC’s recordkeeping obligations. Are you prepared to keep “full, complete, and systematic records” with respect to each swap? Such records must be kept for 5 years after the termination of a swap and meet “ready accessibility” requirements.

7. Preserve your ability to trade with swap dealer counterparties (May 1, 2013)

Even though you may not be a swap dealer, you may need to amend your ISDA and other master agreements with swap dealer counterparties to continue trading with such counterparties, in order to satisfy their Dodd-Frank compliance obligations. ISDA has published the August 2012 Dodd-Frank Protocol, which allows counterparties to amend their ISDA (and other) master agreements accordingly and has provided an online “ISDA Amend” process that allows counterparties to amend their master agreements with counterparties through an online exchange. Over 4800 parties have already adhered to the Protocol.

8. Prepare for end-user exception to mandatory clearing (September 9, 2013 for certain swaps)

If you’re planning to continue trading in uncleared swaps, you or your counterparty must satisfy the requirements of the “end user exception” to mandatory clearing, unless the swap is of a type the CFTC has not yet determined is “required to be cleared.” Are your swaps required to be cleared? Is one of the counterparties using the swap to “hedge or mitigate commercial risk,” as required to elect the exception? If an SEC filer, do you have the required board approval in place to trade in uncleared swaps and a process for annual or more frequent committee review based on appropriate triggering events?

9. Stay tuned for additional CFTC rulemakings, no-action and interpretive letters, and court challenges to CFTC rules

The CFTC has some important unfinished rulemakings to complete in 2013, and additional no-action and interpretive letters by the agency and court challenges to its rules are practically a certainty. Stay tuned during the year for further developments on position limits, capital and margin rules, and other important rulemaking areas.