ABA Webinar - Cleared Swap Documentation

8/10/2019 ABA Webinar - Cleared Swap Documentation

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The Swap Documentation Subcommitteehe Swap Documentation Subcommittee

of the ABAs Futures and Derivatives Law Committee

Webinar:

New Cleared Swap Documentationew Cleared Swap Documentation

for U S Markets

Wednesday, August 15, 2012

12 noon (Eastern Time)

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AGENDA

. . .

Claire Hall, White & Case2. Distinguishing Futures vs. Uncleared Swaps vs. Cleared Swaps

Execution/Documentation

Lauren Teigland-Hunt, Teigland-Hunt LLP

3. Futures Customer Account Agreement vs. ISDA Land

Warren Davis, Sutherland. eare er va ves ransac on en um

Maria Chiodi, Credit Suisse

5. FIA/ISDA Cleared Derivatives Execution Agreement

onathan Chin ones Da

6. Other Related Issues

Jonathan Ching & Warren Davis

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Section 723 a 3 of the Dodd-Frank Wall Street Trans arenc and Accountabilit Act

of 2010 (The Dodd-Frank Act) provides:

It shall be unlawful for any person to engage in a swap unless that person submits such swap

for clearin to a derivatives clearin or anization that is re istered under this Act or a

derivatives clearing organization that is exempt from registration if the swap is required to

be cleared.

Section 763 a of the Dodd-Frank Act sets forth a corollar rovision a licable to

security-based swaps.

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cleared?

When will the clearing requirement take effect?

How much lead time will clients have to prepare for compliance?

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When will we know with certainty which products will be required to be

c eare

The Dodd-Frank Act tasked the regulators with reviewing classes of

swaps to determine which of these products should be required to be

cleared.

Derivatives clearing organizations (DCOs) submitted to regulators a listof roducts the lan to acce t for clearin .

Products eligible for clearing as of the date of enactment of the

Dodd-Frank Act were deemed submitted to the CFTC.

require that certain classes of credit default swaps (CDS) and interest rate

swaps (IRS) be cleared by DCOs.

Comment Deadline: Se tember 6 2012

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When will clearing requirement take effect?

.

will be triggered once the CFTC has issued a determination that a

product is required to be cleared.

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How much lead time will clients have to prepare for compliance?

Final determination on initial products to be required to be cleared isexpected in November 2012 (aka T)

Category 1 Entities will be required to comply with mandatory clearingrequirements by T + 90 days

Category 1 Entities included swap dealers, major swap participants andactive funds

Active fund any private fund as defined in Section 202(a) of theInvestment Advisors Act of 1940, that is not a third-party subaccount

an t at executes 200 or more swaps a mont ase on a mont yaverage over the 12 months preceding the Commission issuing amandatory clearing determination.

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How much lead time will clients have to re are for com liance?

Category 2 Entities will be required to comply with mandatory clearing

requirements by T + 180 days

Category 2 Entities include private funds that are not active funds; employee benefit plans; a

person predominantly engaged in activities that are financial in nature as defined in Section

4(k) of the Bank Holding Company Act of 1956.

Category 3 Entities will be required to comply with mandatory clearing

requirements by T + 270 days

Category 3 Entities include third party subaccounts and all others.

Third party subaccount a managed account that requires specific approval by

the beneficial owner of the account to execute documentation necessary for

executing, confirming, margining or clearing swaps.

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What advance preparation can a client do today?

o Identify prospective clearing members for clearing swaps.

o Set documentation priorities.

o Initiate discussions about preferred documentation terms.

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er vat ves

Lauren Teigland-Hunt

e g an - un ew or

2011

TH

LLP

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Overview Exchange Traded Contracts v. OTC Derivatives

Futures Execution and Clearing

Uncleared OTC Swap Documentation

Cleared Swap Execution and Clearing

FIA-ISDA Execution Agreement

FIA Addendum

2011

TH

LLP

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Exchange-Traded vs OTC Derivatives Standardized exchan e-traded contracts

Futures contracts Listed options

Over-the-counter (OTC) derivatives are privately-

traded on a centralized exchange

Forwards

waps OTC Options

2011

TH

LLP

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Futures Execution and Clearing:

DCO/DCO/Futures Give-Up

ClearinghouseClearinghouse

5 Resulting clearedtrade5

Resulting

cleared trade

no disclosure to

clearing member ofexecuting

counterparty

XYZ FCM/

Clearing

Member

Other

FCM/Clearing

Member

Matched trade

submitted for

clearing

Bilateral

Alpha

Fund

Alpha

Fund

Floor

Trader/Local

ABC

Executing

Broker*

Anonymous

Market

Anonymous

Market1 2 2

Give upear ngAgreement

Sends order Representssale / enters

order

Enters

order

* Futures Give-Up Arrangement: representation of Alpha by Executing Broker to Anonymous Market. ABC Executing Broker

3 Trade executed on

Anonymous Market

.

with anyone in the market to secure best price. XYZ FCM does not know identity of trade counterparties.

2011

TH

LLP

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OTC Swap Execution (no clearing)

Bilateral ISDA Master Agreement

e ween p a un an

Governs

TRADE EXECUTED

DIRECTLY

OFF-EXCHANGE

DBAlphaFund

Sell Buy

2011THLLP

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OTC Uncleared Swap Documentation

ISDA

(with Schedule &CSA)

TradeConfirmation

TradeConfirmation

TradeConfirmation

e.g., n eres ra eswap) e.g., equ y caoption) copper orwarpurchase/sale)

2011THLLP

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Cleared Swap Execution and Clearing

CME Contract 2CME Contract 1

CMESell

DBSIBuy

CS (asAlphas

FCM/Clearer)

Sell

CMEBuy

CME (as DCO)

Cleared Trade

Results

(subject to

Execution Agreement

b/t Alpha andDB)

IF

REJECTED

IF

ACCEPTED

BilateralClearingResults

TRADE EXECUTED

Submitted

for Clearing

DB

Agreement

Sell Buy

OFF-EXCHANGE or on SEF

Fund

Bilateral Execution

A reement

2011THLLP

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Warren N. Davis

Futures Customer Account Agreements

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Were Not in ISDA-Land Anymore

Its best to think of Cleared-Swaps Land as a Hybrid ofISDA-Land and Futures-Land

ISDA LANDFUTURES LAND

CLEARED

SWAPS LAND

2012 Sutherland Asbill & Brennan LLP

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Were Not in ISDA-Land Anymore (Cont.)

ISDA Land

(principal to principal)

Futures Land

(agency relationship)

Risks

Operational RiskLiquidity Risk

Early Termination Risk

-

Operational RiskLiquidity Risk

Early Termination Risk

Documentation

ISDA Master Agreement

Schedule

CSA

Customer Account Agreement

Give-Up Agreement

Paragraph 13

Cash Flows

Periodic Swap Payments

Variation Margin

Purchase Price

Sales Proceeds

Variation Margin

PartiesCounterparties

Executing Dealers

Futures Commission Merchants


us o ans er va ves ear ng

Organizations

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Were Not in ISDA-Land Anymore (Cont.)

Cleared Swaps Land

(agency relationship)

Investment Risk

Counterparty

credit risk is

re laced b

RisksOperational Risk

Liquidity RiskEarly Termination Risk

liquidity and early

termination risks

Documentation

Cleared Derivatives Transactions Addendum

Cleared Derivatives Execution Agreement

Upfront PaymentsNew agreements

Cash Flows

Initial Margin

Variation Margin

Sales Proceeds

Periodic Swa Pa ments

New payment

obligations

PAI (Price Alignment Interest)

Counterparties

Executing Dealers Additional parties


ar es utures omm ss on erc ants

Derivatives Clearing Organizations

[Custodians]21


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Adoption of the Futures Model for Cleared

Swa s Cont.


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Typically not negotiated

-

Not standardized Althou h futures customer account a reements tend to

cover the same issues, each futures commission merchant

has its own version and, accordingly, there are often

nuanced differences between them

Significantly different from ISDA Master Agreement

Relevant because the provisions thereof will apply to

e ex en ey are no a resse y e en um See Section 9 of the FIA Addendum, the Inconsistency

provision


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T icall Address Amon Other Thin s

Margin Requirements

ven s o e au an qu a on o os ons

Payment Obligations

Security Interests

Termination Ri hts

The Transfer of Funds

Assignment


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Under the Typical Futures Customer

Account A reement

The FCM may unilaterally set and increase margin

re uirements over and above clearin house re uirements at

any time

There are no cure periods for events of default

n may ec are an even o e au o ave occurre , or

avail itself of remedies as if an event of default has occurred, if it

deems it necessary for its protection

Either party may terminate the agreement with notice

FCMs may use futures collateral to satisfy obligations under

ot er agreements w t t e or ts a ates The FCM may assign the agreement at any time


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Key Futures Customer Account Agreement

Provisions to Ne otiate

Who the parties to the futures customer account agreement are

,

Margin amounts, payment obligations and eligible collateral Termination rights

Events of default

Porting rights

Position limits

FCMs treatment of customer collateral

Notices and objections thereto and assignment

Partial porting (porting is generally addressed only in the

context of termination of the futures customer account


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ddendum

Maria Chiodi

Credit Suisse

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Purpose of FIA Cleared Derivatives Addendum

To supplement the terms of a futures clearing agreement between

an FCM and its customer to allow for the clearin of swa s.

Necessary because futures clearing agreements typically do not

expressly cover cleared swaps.

Clearing of swaps can present unique issues (e.g., most swaps are

executed off-exchange).

Unlike addenda published previously that were specific to

particular DCOs (e.g., CME and ICE Trust), the FIA Addendum is

generic in nature and is expected to replace the DCO-specific

.

Many parties are already negotiating cleared derivatives addendabased on recent drafts of FIA Addendum.

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Status/Scope of FIA Addendum

StatusofFIAAddendum

Afteraseriesofdeliberationsthattookplaceovermorethan18

months,anFIAWorkingGrouprecentlycompletedtheFIA

Addendum.

ScopeofFIAAddendum

All

swaps,

forwards,

options

or

similar

transactions

w e erexecu e n e mar e or ra e ona or

aDCM)thataresubmittedtoandacceptedforclearingby

aclearingorganization.

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Content of FIA Addendum

Definitions

and Customer Applicable Law (including DCO/SEF rules);

Authorizations

Transactions Not Accepted for Clearing m tat on o a ty

Transfer of Positions (aka portability)

Tax Provisions

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Section 7 of FIA Addendum

Liquidation

Liquidation Date upon a Liquidation Event. -

Transactions in order to liquidate customer trades

as soon as commercially reasonable. In addition Risk-reducing Transactions and Mitigation

Transactions are possible by Clearing Member/its

affiliates.

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Section 7 of FIA Addendum

Liquidation (contd)

If Clearing Member, after commercially

reasonable efforts, determines that close-out

ra es are no rea y ava a e or wou no

(or would require solicitation of quotes that

,

Clearing Member shall be entitled to value

7(b)(i)(B) of the Addendum.

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Liquidation Standard means, with respect to determining whether and when to take a course of action, and

in taking any such course of action, on or following a Liquidation Date, a standard

that entails acting in good faith, in accordance with Applicable Law and using

result;

provided further, that Clearing Member may effect Closeout Transactions, Risk-

reducing Transactions and Mitigation Transactions with Clearing Member or Clearing

em er s a a es, an an a a e o ear ng em er may e ec a ga on

Transaction with Clearing Member or another of Clearing Members affiliates, only to

the extent that such transactions are executed on an arms length basis and at then

prevailing market prices, as determined in any commercially reasonable manner byear ng em er;

provided, however, if Clearing Member, acting reasonably and in good faith,

determines there are no relevant prevailing market prices for such transactions at

such time or that actively soliciting quotations for such transactions would produce

prevailing market prices for such transactions that would not satisfy the Liquidation

Standard, such transactions may be executed on an arms length basis at a

commercially reasonable price.

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FIA/ISDA Cleared Derivatives Execution A reement

Jonathan Ching

August 15, 2012

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What is an Execution Agreement? A bilateral a reement between a customer and its counter art

that governs the submission of a swap for clearing andestablishes procedures for when a swap is not accepted forclearing

n wor ng group cons s ng o uy-s e an se -s e

swap market participants developed a form of ExecutionAgreement last year (published in June 2012)

-,party or four-party agreement that included the parties clearingmembers as parties to the agreement

The CFTC adopted final rules earlier this year that prohibit entry into- -

The FIA/ISDA working group is expected to publish a secondversion of the form Execution Agreement that takes into account theCFTCs rules

Generally, the form Execution Agreement is intended to be thestarting point for negotiations

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Submitting a Swap for Clearing

Swa is executed bilaterall The dealer counterparty must submit the swap forclearing to the relevant clearing house:*

than the close of business on the day of execution ifthe swap is subject to mandatory clearing

,later than the next business day after the executionof the swap or the agreement to clear (if later than

execution Customer receives notice, as does its clearing member

Notice specifies the details of the swap

*

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Submitting a Swap for Clearing (Cont.)

or reject each trade submitted for clearing as quickly

as would be technologically practicable if fully

au oma e sys ems were use

Once a swap is accepted for clearing, the swapbetween the dealer and customer is re laced with

two separate cleared swap transactions and the

Execution Agreement no longer applies

* Note that the current version of the FIA/ISDA Execution Agreement requires a dealer

counterparty to submit a swap for clearing within 30 minutes of execution and that a

customer must affirm or reject a swap within 2 hours of receiving notice. The Execution

Agreement is subject to Applicable Law, however, and, as such, the 30 minute and 2 hour

timeframes are superseded by the above.

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Transactions Not Accepted for Clearing

,for clearing, the dealer has 3 options:

If the swap is not accepted for clearing because

it was not accepted by the customers clearing

member, the dealer may clear the swap itself orthrou h an affiliate if it or its affiliate is a

clearing member)

If the swap is not subject to mandatory clearing,e ea er may accep e swap as an over- e-

counter, bilateral transaction

The dealer ma terminate the swa in which

case the dealer or customer will pay an EarlyTermination Amount

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Cleared Swa Documentation: Other Issues

Jonathan Ching (Jones Day) and Warren Davis (Sutherland)

August 15, 2012

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Assume you execute 30-yr USD fixed to floating rate

swa with Dealer X then submit that trade for clearin :

Term is reduced to the length of notice requiredbefore FCM can exercise termination rights

not individually negotiated

Both parties are required to post margin

Customer counterparty is CCP (not dealer bank)

Valuation is determined by CCP and no bespoke

spu e r g s may e nvo e

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FCM will impose credit terms on clients that allow

,

fund obligations and other capital requirements. Trading desks seek to mitigate the operational risk

during the period from trade execution to

acceptance for clearing.

necessarily consistent agendas within a single

institution will help clients to better analyze their

ocumen a on nee s.

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There is a wide discrepancy in expectations about the

market for cleared OTC derivatives:

How quickly will trades be accepted for clearing?

How much liquidity will exist for these trades once

How well will the operational systems work and howoften will trades break?

,for parties to resubmit trades that are rejected fromclearing?

to these questions.

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ABA Webinar - Cleared Swap Documentation

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