Dodd Frank Issues: End-user Check List

By Gordon E. Goodman

5/30/13

The following Dodd Frank check list is intended to cover many of the issues and questions that are confronted by “end-users” as they implement changes in their governance and operations to comply with the rules and regulations of the Dodd Frank Act. It is not comprehensive however, and each end-user should consider its own unique circumstances in designing an appropriate compliance program.

  1. End-user / Category 3 Status
  2. CATEGORY 3 STATUS: End-user or Category 3 status can only be elected if a company is not a Category 1 or Category 2 company. Category 1 includes swap dealers (SD) and major swap participants (MSP). Category 2 entities include commodity pools, most hedge funds, and persons predominantly engaged in activities that are “financial in nature” as defined in Section 4(k) of the Bank Holding Company Act of 1956.
  3. FINAL RULE (see below): Many of the issues discussed in this analysis refer back to the “End-User Exception to the Clearing Requirement for Swaps; Final Rule,” 77 Fed. Reg. 42560 (July 19, 2012),
  4. FINANCIAL ENTITY: To elect end-user status, a company must not be a “financial entity”:
  5. a swap dealer or major swap participant;
  6. a security-based swap dealer or a major security-based swap participant;
  7. a commodity pool;
  8. a private fund (a subset of investment companies as defined in the Investment Company Act of 1940);
  9. an employee benefit plan or governmental plan (as defined under the Employee Retirement Income Security Act of 1974); or
  10. a person predominantly engaged in activities that are in the business of banking, or in activities that are financial in nature (as defined under the Bank Holding Company Act of 1956).
  11. GAAP VS IFRS: Companies should make sure that the activities that are “financial in nature” definition in the Bank Holding Company Act shown above is not an issue. For some European companies, the IFRS treatment of derivatives (which are reflected in their balance sheet on a gross basis) may cause an issue versus the US treatment of derivatives under GAAP (which are reflected on a net basis).
  12. Compliance with all requirements for electing the end-user exemption, in addition to adopting the board resolutions
  13. REQUIREMENTS
  14. BOARD RESOLUTION: The Board or an appropriate committee of the Board (e.g., the Audit Committee, the Finance Committee, or the Risk Management Committee) should adopt an annual resolution electing the end-user exemption from clearing for all qualified swaps. This applies to companies that qualify as an issuer of securities registered under section 12 of, or that are required to file reports under section 15(d) of, the Securities Exchange Act of 1934.Companies that seek exemption from clearing, and that qualify as end-users, should adopt a board resolution making this election on or before September 2013 (or before their swaps come under the mandatory clearing requirements if not yet covered) since their counter-parties will probably soon ask for such a document. A copy of this resolution should be filed with the appropriate swap data repository (SDR), see below.
  15. HEDGING: The swaps used by an end-user should be used to hedge or mitigate its commercial risk or should be eligible as bona fide hedges under the Commodity Exchange Act or as accounting hedges under FASB rules.
  16. DE MINIMIS AND MSP TESTS: Companies should insure that they meet the SD test (called the de minimis test) and the MSP tests. In particular, end-users should make sure that they are not dealing in swaps with “special entities” that include various government organizations and co-ops. The $8 B threshold that generally applies to the de minimis test drops to $600 MM for special entities that engage in utility operations and to $25 MM for non-utility special entities. Companies should insure that they are not and do not inadvertently become a “financial entity” (see above). Also, please note that the hedge exemptions that are available under the first of the two MSP tests become unavailable to “financial entities.”
  17. FINANCIAL OBLIGATIONS: A company must show how it will meet its financial obligations from one of the following described methods:
  18. A written credit support agreement (this could be the Credit Support Annex or CSA attached to the ISDA);
  19. Pledged or segregated assets (including posting or receiving margin pursuant to a credit support agreement or otherwise);
  20. A written third-party guarantee (I do not think a parent guarantee would qualify as a “third party” guarantee);
  21. The electing counterparty's available financial resources (this is an alternative to the CSA route); or
  22. Means other than those described above.
  23. SDR FILING: In accordance with the final rule (see below), the Board resolution should be provided to the end-user’s SDR (swap data repository). This is in lieu of filing the resolution with the Commission (as directed by the Commission). For this reason, and for future filing purposes, end-users should establish a relationship with an SDR as soon as possible.
  24. Adoption of board resolutions at the parent company level: Should board resolutions also be adopted separately by subsidiaries that are the actual ISDA counterparties?
  25. PRINCIPAL VS AGENT ISSUE: The CFTC has indicated that an agent affiliate could utilize the end user exception from clearing for an affiliated subsidiary that qualifies as the end user exception (even though the agent itself does not qualify). Conversely, a principal affiliate that does not qualify cannot utilize the end user exception that would be available to its affiliated subsidiary. Though this is not directly on target to the parent/subsidiary issue of whether a single parent company board resolution will suffice, I think it points out the fact that the CFTC views both entities (i.e., the one entering into the swaps and the other for whom the swaps were being performed) as separate entities which will either qualify or not qualify for their separate end user exceptions.
  26. NON-US ENTITY ISSUE: Nothing in the regulations or follow-up analysis suggests that actual ISDA counterparties do not need to make separate board resolutions. To the extent that a company determines that the board resolution requirement generally does not apply (perhaps if the parent and its subsidiaries are not US public companies, and are therefore not subject to the filing requirements of the Securities Exchange Act, see above), then it may want to rely on the parent Board resolution only. To the extent that it chooses not to make separate Board resolutions for its foreign subsidiaries, then it may still want to consider making a separate resolution for its US subsidiary.
  27. CFTC reporting requirements for non-financial end users starting April 10 2013
  28. REPORTING HIERARCHY:
  29. EXCHANGE (SEF/DCM) BASED TRANSACTIONS: No further action required.
  30. SWAPS WITH SWAP DEALERS: To the extent that an end-user does a swap with an SD counterparty, then the SD is responsible for reporting to the SDR.
  31. SWAPS WITH MSPs: To the extent that an end-user does a swap with an MSP counterparty, then the MSP is responsible for reporting to the SDR.
  32. SWAPS WITH FINANCIAL ENTITIES: To the extent that an end-user does a swap with a financial entity, then the financial entity is responsible for reporting to the SDR.
  33. FOREIGN END USER WITH DOMESTIC END USER: The U.S. person is responsible for reporting versus the non-U.S. person.
  34. DOMESTIC WITH DOMESTIC OR FOREIGN WITH FOREIGN: The parties must agree as to who is the reporting party.
  35. REAL TIME REPORTING: Real time reporting was originally scheduled to start on 4/10/13, but was postponed by a recent No-action Letter from the CFTC, see Revised Schedule below.
  36. PRE-ENACTMENT AND TRANSITION SWAPS (§ 46, Swap data reporting for pre-enactment swaps and transition swaps): The rule governing pre-enactment and transition swaps can be found at Swaps that were in effect on 7/21/10 are “pre-enactment swaps,” and swaps that were executed after 7/21/10 but before 4/10/13 are “transition swaps.” There is also a higher level of reporting required for transition swaps that were executed after 4/25/11 but before 4/10/13. All of these were to have been reported on or before the original deadline of 4/10/13. Approximately the same reporting hierarchy applied to these pre-4/10/13 swaps as to the post-4/10/13 swaps (SD, then MSP, then financial entity, etc.), and the reporting (if required) is to be made to the SDR.
  37. REVISED SCHEDULE UNDER THE 4/9/13 NO-ACTION LETTER: On 4/9/13, the CFTC issued Letter No. 13-10 ( which changed the reporting schedule for end users (i.e., non-financial counterparties) to the following:
  38. Credit/interest rate swaps entered into from 7/21/10 to 4/10/13: 7/1/13
  39. All swaps entered into from 4/10/13 to 7/1/13: 8/1/13
  40. Equity/commodity swaps entered into from 7/21/10 to 4/10/13: 8/19/13
  41. All swaps that were in existence on 7/21/10: 10/31/13
  42. CFTC recordkeeping requirements for new and existing swaps
  43. DODD FRANK RECORDKEEPING ( End-users must keep full, complete, and systematic records. The recordkeeping requirements apply to pre-enactment, transition, and post-4/10/13 records. Records should be kept in electronic format unless they were originally created in paper format and have been thus maintained since their creation. Records must be kept for five (5) years from the termination date of the swap, with the exception of audio records which must be kept for one (1) year from the termination date.
  44. RELATED PHYSICAL TRANSACTIONS: Please note that the same requirements apply to physical transactions for which hedge treatment is claimed either with respect to the exception from mandatory clearing or the exception from the SD de minimis or MSP tests listed above.
  45. Update on any developments re margin requirements
  46. UNCLEARED SWAPS WITH SWAP DEALERS ( The CFTC has proposed rules that would require SDs to collect initial and maintenance margin from end-users for un-cleared swaps. These rules, if enacted,may supersede contractual arrangements as between end-users and their SDs that rely on parent guarantees only. For this reason, end-users may want to reconsider entering into negotiated CSAs with their SD counterparties. Having a CSA in place (hopefully with some flexibility on margin requirements) would also be a simple answer to the requirement that an end-user demonstrate its ability to meet its financial obligations.
  47. UNCLEARED SWAPS WITH NON-SDs: The proposed CFTC rule would not impose new margin requirements in transactions as between two end-users.
  48. Possible adherence to ISDA’s August 2012 DF Protocol
  49. ISDA PROTOCOL: Consider adopting the ISDA’s new DF protocol.
  50. Obtain an LEI/CICI for the parent company and each subsidiary counterparty
  51. LEI/CICI: Each corporate entity that engages in swaps transactions must obtain a legal entity identifier (LEI or CICI).