DERIVATIVES MARKETS:
CROSS-BORDER REGULATION
PREPARED FOR COLADE 2014: XXXIII
CONGRESO LATINOAMERICANO DE DERECHO
FINANCIERO
NOVEMBER 20, 2014
STEPHEN M. HUMENIK
Overview
•
•
•
•
•
•
The Financial Crisis and Regulatory Response
U.S. Commodity Futures Trading Commission
The Dodd-Frank Act
European Financial Reform
Cross-Border Issues – CCP Recognition
Covington - Key Attorney Profiles
2
THE FINANCIAL CRISIS AND
REGULATORY RESPONSE
3
The Financial Crisis: International Reaction
•
In September 2009 the leaders of the Group of 20 (G-20)—whose
membership includes the United States, the European Union, and 18 other
countries—agreed to a five part framework for global OTC derivatives
reform:
1. Central clearing of OTC derivatives;
2. Increased standardization of OTC derivatives;
3. Exchange trading of standardized derivatives;
4. Reporting derivatives trades to trade repositories, and
5. Increased capital requirements for non-cleared derivatives
Argentina
Australia
Brazil
Canada
China
France
Germany
India
Indonesia
Italy
Japan
Republic of Korea
Mexico
Russia
Saudi Arabia
South Africa
Turkey
United Kingdom
United States
European Union
4
U.S. COMMODITY FUTURES
TRADING COMMISSION (CFTC)
5
The Commission
•
The CFTC is lead by 5 Commissioners – Nominated by President, “advice and
consent” of the Senate

Chairman Timothy Massad*
•
Controls agenda, serves at the pleasure of the President.

Commissioner Mark Wetjen

Commissioner Sharon Bowen

Commissioner Christopher Giancarlo

Commissioner (Vacancy)
•
The CFTC regulates:

Futures – subject to CFTC regulation since the 1920s.

Options on Futures – subject to CFTC regulation since the 1920s.

Swaps – subject to CFTC regulation since the passage of the Dodd-Frank
Act on July 21, 2010, effective July 21, 2011. Swaps include broad-based
indices.

Security-Based Swaps – single name CDS and narrow-based indices
subject to SEC jurisdiction since the passage of the Dodd-Frank Act.

Spot, cash, physical or forward transactions –transactions in the “cash
market” – are exempt from CFTC regulation.
6
CFTC Operations
•
•
•
•
•
680 Staff (2010-2012)
707 Staff (2013)
667 Staff (2014)
•
1,015 Staff (proposed 2014)
920 Staff (2015 request)
 SEC had 3,958 (2012)
Headquartered in DC with offices in New York, Chicago, Kansas City
Division of Market
Oversight
Office of the Executive
Director
Division of Clearing and
Risk
Office of Public Affairs
Office of International
Affairs
Office of Legislative Affairs
Division of Enforcement
Office of the General
Counsel
Office of the Secretariat
Division of Swap Dealer
and Intermediary Oversight
Office of the Chief
Economist
Office of the Inspector
General
Office of Data and
Technology
7
THE DODD-FRANK ACT
8
Clearing
Clearing
Swap Dealer Oversight
Price Transparency
Swaps Market Reform –
Reduction of Systemic Risk
Central clearing is one of the three major building blocks of Dodd-Frank swaps market reform -- in
addition to promoting market transparency and bringing swap dealers under comprehensive
oversight -- and this rule completes the clearing building block.

Central clearing lowers the risk of the highly interconnected financial system. It also democratizes
the market by eliminating the need for market participants to individually determine counterparty
credit risk, as now clearinghouses stand between buyers and sellers.

In a cleared market, more people have access on a level playing field.

Small and medium-sized businesses, banks and asset managers can enter the market and trade
anonymously and benefit from the market’s greater competition.
Chairman Gensler, November 28, 2012 (Statement on Clearing Determinations).
9
Clearing Rules
• DCO Core Principles, Risk Management
• Protection of Cleared Swaps Customer
Contracts and Collateral
• Documentation, Straight Through Processing,
and FCM Risk Management
• Mandatory Clearing Determinations
10
Trading and Clearing Market Structure
Executing
Broker
Asset
Manager
(Trader) on
behalf of
Customers
Executing
Broker
(FCM)
Exchange
(DCM) or Swap
Execution
Facility
||
||
Clearing House
Executing
Broker
Executing
Broker
(FCM)
Clearing
Clearing
Brokers (FCMs)
Brokers (FCMs)
Asset
Manager
(Trader) on
behalf of
Customers
11
DCO Core Principles
•
Section 725(c) of the Dodd-Frank Act amended Section 5b(c)(2) of the
Commodity Exchange Act (CEA), sets forth core principles with which a DCO
must comply to be registered and to maintain registration as a DCO. The DoddFrank Act revised the 14 existing core principles and added four new ones.
– Financial resources
– Participant and product eligibility
– Risk management
– Settlement procedures
– Treatment of funds
– Default rules and procedures
– Rule enforcement
– System safeguards
– Reporting
– Recordkeeping
– Public information
– Information sharing
– Antitrust considerations
– Legal risk considerations
12
DCO Core Principles – Risk
Management
•
•
•
Core Principle D - Risk Management:
– Regulation 39.13 sets forth the requirements that a DCO would
have to meet to comply with Core Principle D.
– The regulation addresses requirements for a DCO’s risk
management framework (including margin methodology and
coverage, price data, daily review and periodic back tests) and
other risk control mechanisms (including risk limits, review of large
trader reports, stress tests, and reviews of clearing members’ risk
management policies and procedures).
The Dodd-Frank Act also provides for additional regulation by the
Federal Reserve of Systemically Important Derivatives Clearing
Organizations or SIDCOs designated by the Financial Stability
Oversight Counsel.
In terms of DCOs, the following are SIDCOs:
– Chicago Mercantile Exchange, Inc.;
– ICE Clear Credit LLC; and,
– The Options Clearing Corporation
13
SEGREGATION UNDER THE
COMPLETE LEGAL SEGREGATION
(LSOC) MODEL
14
15
Information Exchange and Regulation Under the
CLS/LSOC Model
Responsibilities of
the DCO:
1) Take
appropriate
steps to confirm
the information
it receives from
the DCO.
2) Ensure that the
FCM is
providing the
DCO with the
required
information.
DCO
FCM
An FCM must share with the
DCO:
• One time: Information
sufficient to identify a
customer. (This must only
be done the first time the
FCM intermediates a trade
for a customer).
• Daily: Information
sufficient to identify the
customer’s portfolio of
rights and obligations.
16
Complete Legal Segregation (CLS)
Same macro structure as Future Model
DCO
FCM Prop.
Margin
Account
DCO
Capital
Account
Omnibus
Collateral
Account
(OCA)
FCM
FCM Customer
Margin Account
C1
(Hedge Fund)
C2
(Trust)
FCM Customers
C3
(Pension
Plan)
Internal Structure of OCA
C1
Collateral
C2
Collateral
C3
Collateral
FCM Excess
Collateral
Difference is in the details:
At the DCO level:
•
All collateral belonging to an individual cleared swaps
customer (CSC) must be individually identifiable within the
omnibus account (Reg 22.12).
•
DCOs are not permitted to use CSC collateral to margin,
guarantee, or secure the obligations of the FCM or any
other CSC (Reg 22.15).
•
Once per day DCOs must calculate and record:
1. the amount of customer collateral required for each
FCM CSC.
2. The sum of CSC collateral in the omnibus account.
At the FCM level
• CSC collateral may continue to be comingled (Reg 22.2) but
all customer collateral must be individually identifiable within
the comingled account (Reg 22.12).
• FCMs are mandated to use their own capital to cover the
negative account balance of a CSC. FCMs may contribute
to the Omnibus account in advance to preempt any account
deficiencies (Reg 22.2).
• FCMs are prohibited from imposing or permitting the
imposition of a lien on all cleared swap collateral, including
any residual financial interest which the FCM may have due
to their individual contributions to the customer collateral
17
account (Reg 22.2).
CLS(LSOC) in case of FCM Default
FCM Customers
Step 1.
Customers post collateral to
FCM.
Step 2.
FCM prop trades go against the
FCM.
Step 3.
FCM withdraws excess collateral
from OCA.
Step 4.
FCM fails to meet DCO margin
call on its prop margin account.
Step 5.
DCO liquidates FCM prop margin
account.
Step 6.
FCM customer funds in the OCA
are ported to a solvent FCM.
FCM
1.
FCM Customer
Collateral Account
C1
C2
2.
FCM Prop Trading
Account
C3
6.
3.
DCO
OCA
C1
C2
C3
Excess
Collateral
DCO
Capital
4.
FCM prop
trading margin
account
5.
The CLS model significantly enhances the transparency of the contents of the OCA. As such, any issue regarding the right of
the FCM to collateral in the OCA will be more easily resolved.
18
Clearing & Trading Mandates
•
•
Asset classes made subject to mandatory clearing, and, later, mandatory trading are:
– Interest rates (certain products are subject to mandates)
– Credit (certain products are subject to mandates)
– Energy (expected)
– NDFs (expected - the proposal could include India, Korea, China, Malaysia, Indonesia, Taiwan,
the Philippines, Brazil, Chile, Columbia, Russia, and Peru – all against the US Dollar)
Process for the Commission to make a clearing determination:
– Rule proposal
– 90 day review period, which includes a 30 day comment period
– Consideration of comments and incorporation into a final rule
– Finalization of the rule
– Publication in the Federal Register and phasing:
Category 1
Category 2
Category 3
– 90 days after publication, Category 1 entities must comply (SDs/MSPs and “Active
Funds” (Private Funds trading 200+ swaps per month/past year) that are not “3rd party
subaccounts)
– 180 days after publication, Category 2 entities must comply (Commodity Pools, Private
Funds that are not “Active Funds,” and people “predominantly engaged in” banking
activities or activities that are financial in nature, that are not “3rd party subaccounts”)
– 270 days after publication, Category 3 entities must comply (pension funds, “3rd party
subaccounts,” and all others subject to the mandate)
19
MARKET PARTICIPANT OVERSIGHT
20
Market Participant Categories
Swap Dealers
• Holds itself out as a
dealer in swaps;
• Makes a market in
swaps;
• Regularly enters into
swaps with
counterparties as an
ordinary course of
business for its own
account; or
• Engages in any activity
causing it to be
commonly known in the
trade as a dealer or
market maker in swaps
• Also referred to as
“Dealers” or “Liquidity
Providers.”
• 105 Provisionally
Registered
• Examples:
• Bank of America
• Goldman Sachs
• JPMorgan
• Mizuho
• Morgan Stanley
• Wells Fargo
• BP
• Shell
• Cargill (Limited
Designation)
Major Swap
Participants
• Not a swap dealer, and
• Maintains a substantial
position in swaps
• 2 Provisionally
Registered
• Examples:
• Cournot Financial
Products LLC
• MBIA Insurance
Corporation
Intermediaries
Financial
Entities
Commercial
End Users
• Futures Commission
Merchants (FCMs)
• engaged in soliciting or
in accepting orders for
the purchase or sale of
futures and swaps;
• accepts any money,
securities, or property to
margin, guarantee, or
secure any trades
• Swap dealer or securitybased swap dealer;
• Major swap participant or
major security-based
swap participant;
• Commodity pool;
• Private fund;
• Employee benefit plan;
• Banks (total assets of
$10 billion or more)
• Not a financial entity;
• Using swaps to hedge or
mitigate commercial risk;
and
• Notifies the CFTC how it
meets its financial
obligations associated
with entering uncleared
swaps
• FCMs are also referred
to as Clearing Firms or
Clearing Members of a
Derivatives Clearing
Organization or
Clearinghouse.
• Examples
• Hedge funds
• Commodity pools
• Insurance companies
• Examples
• Commodity producers
• Energy companies
• Introducing Brokers
(IBs)
• engaged in soliciting or
in accepting orders for
the purchase or sale of
futures and swaps;
21
FCM Regulations
•
•
•
•
•
•
•
•
•
•
•
Segregation of Customer Funds
Minimum Net Capital
Disclosure Requirements
Trade Authorization Requirements
Reporting to Customers
Diligent Supervision
Prohibition on Fraud
Financial and Other Filings
Conflicts of Interest
Chief Compliance Officer
Recordkeeping
22
List of Top CFTC-registered FCMs
Futures Com m ission Merchant /
Retail Foreign Exchange Dealer
JP MORGAN SECURITIES LLC
GOLDMAN SACHS & CO
DEUTSCHE BANK SECURITIES INC
NEWEDGE USA LLC
MORGAN STANLEY & CO LLC
MERRILL LYNCH PIERCE FENNER & SMITH
CREDIT SUISSE SECURITIES (USA) LLC
UBS SECURITIES LLC
BARCLAYS CAPITAL INC
CITIGROUP GLOBAL MARKETS INC
RJ OBRIEN ASSOCIATES LLC
ADM INVESTOR SERVICES INC
BNP PARIBAS PRIME BROKERAGE INC
ABN AMRO CLEARING CHICAGO LLC
INTERACTIVE BROKERS LLC
MIZUHO SECURITIES USA INC
MERRILL LYNCH PROFESSIONAL CLEARING CORP
JEFFERIES BACHE LLC
RBS SECURITIES INC
FCSTONE LLC
ROSENTHAL COLLINS GROUP LLC
MACQUARIE FUTURES USA LLC
RBC CAPITAL MARKETS LLC
BNP PARIBAS SECURITIES CORP
HSBC SECURITIES USA INC
JP MORGAN CLEARING CORP
GOLDMAN SACHS EXECUTION & CLEARING LP
WELLS FARGO SECURITIES LLC
STATE STREET GLOBAL MARKETS LLC
Net Capital
Requirem ent
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
2,225,987,881
2,311,493,479
755,262,495
958,281,407
1,653,072,250
1,099,047,995
2,304,170,706
876,345,719
1,456,792,521
1,066,873,079
156,483,823
163,339,879
201,838,470
150,908,832
345,767,280
211,723,805
347,151,822
108,489,520
140,547,216
74,614,248
60,679,597
114,991,728
116,297,701
171,406,255
191,391,550
2,091,725,305
164,120,199
271,413,843
76,947,224
Excess Net
Capital
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
10,883,514,614
11,527,007,399
8,875,442,405
861,486,268
7,680,037,243
8,942,537,322
4,770,063,381
7,259,274,347
6,004,429,331
4,398,024,976
46,737,499
123,615,270
3,164,708,355
249,435,218
1,833,790,558
258,467,515
1,564,089,137
79,873,480
4,600,489,797
47,583,067
20,821,657
54,929,292
995,989,050
1,498,606,024
806,064,054
5,752,729,204
1,421,728,778
2,514,788,129
465,296,670
Custom ers'
Assets in Seg
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
19,393,368,514
18,874,745,143
12,999,496,611
12,753,294,665
10,886,038,710
10,501,298,494
9,774,124,491
7,692,991,261
6,643,497,184
5,563,434,675
4,202,187,210
3,531,779,270
3,041,050,765
2,671,721,876
2,414,483,081
2,369,259,573
2,207,983,214
1,910,329,000
1,833,800,437
1,783,248,016
1,628,252,443
1,545,664,637
1,319,707,639
1,195,432,954
1,162,196,222
1,129,987,543
1,129,117,950
1,089,002,931
931,436,912
Funds in
Separate Cleared
Sw ap
Segregation
$ 4,700,616,746
$ 2,907,864,893
$ 1,818,934,500
$
547,752,676
$ 4,750,430,314
$ 2,384,290,305
$ 9,294,546,312
$ 1,108,237,481
$ 6,861,502,902
$ 5,783,154,955
$
$
13,453,875
$
10,831,500
$
$
$
69,372,333
$
1,000
$
61,763,000
$
178,816,125
$
$
$
21,605,136
$
$
430,744,592
$
578,928,742
$
250,000
$
$ 1,741,820,461
$
415,689,660
23
PRICE TRANSPARENCY –
REPORTING AND TRADING
24
Price Transparency
Clearing
Swap Dealer Oversight
Price Transparency
Swaps Market Reform –
Reduction of Systemic Risk
25
Price Transparency
• Swap Data Repositories
• Swap Execution Facilities and Designated Contract Markets
• Swap Block Trade Sizes
“The more transparent a marketplace is, the more liquid it is for
standardized instruments, the more competitive it is and the
lower the costs for hedgers, borrowers and, ultimately, their
customers.”
- Remarks by Chairman Gary Gensler, Bringing Oversight to
the Swaps Market, International Finance Corporation’s 13th
Annual Global Private Equity Conference, Washington, DC
(May 11, 2011)
26
EUROPEAN FINANCIAL REFORM
27
European Market Infrastructure
Regulation - EMIR
•
•
EMIR imposes:
– an obligation on specific standardised OTC derivatives trades to be
cleared through central counterparties;
– risk mitigation techniques for OTC derivatives which are not
centrally cleared;
– a reporting obligation on all derivatives trades;
– new rules on authorisation, as well as prudential, organisational
and conduct of business rules for central counterparties;
– a registration requirement, as well as operational and transparency
obligations for trade repositories.
EMIR applies to all European Economic Area (“EEA”) financial and
non-financial counterparties which undertake trades in derivatives.
Non-EEA counterparties may also be affected if they undertake trades
and the transaction could have a ‘direct, substantial and foreseeable
effect’ in the EEA.
28
European Market Infrastructure
Regulation - EMIR
•
•
•
EMIR came into force on 16 August 2012.
EMIR’s reporting obligations came into effect on 12 February 2014 for
all types of derivative contracts.
Other issues which have yet to be finalised are:
– the clearing obligation, which is unlikely to take effect until 2015;
– variation margin requirements for uncleared trades, which are
expected to be in force from 1 December 2015.
– initial margin requirements will not be fully in force until 1 December
2019.
29
MiFID II and MiFIR
•
•
•
On 22 May 2014, the European Securities and Markets Authority
(“ESMA”) published a Discussion Paper (ESMA/2014/548) and
Consultation Paper
(ESMA/2014/549), which together herald the launch of its consultation
process for the implementation of the recast Markets in Financial
Instruments Directive (“MiFID II”) and Markets in Financial Instruments
Regulation (“MiFIR”).
The publication of these two documents represents the first step in the
process of translating the recently agreed texts of the MiFID II and
MiFIR requirements into practical rules and regulations.
30
MiFID II and MiFIR
•
Both the Discussion Paper and Consultation Paper cover many of the
same topics, including:
– Commodity Derivatives (including position limits)
– Open Access (access to central counterparties, trading venues and
benchmarks)
– Market Infrastructure (requirements for organisation of new trading
venues and impact of the new obligation to trade on those venues)
– Investor Protection
– Algorithmic and High Frequency Trading (defining terms and
regulating activities)
– Third Country Access (treatment of third country firms accessing
EU customers)
– Reporting of Instruments
– Transparency Requirements for Instruments
31
CROSS-BORDER ISSUES – CCP
RECOGNITION
32
Derivatives Trades Cross Borders
Source: www.united.com
33
Financial Stability Board
Area
Standard
Issuing Body
Macroeconomic Policy and Data Transparency
Monetary and financial policy
transparency
Fiscal policy transparency
Data dissemination
Code of Good Practices on Transparency in Monetary
and Financial Policies
Code of Good Practices on Fiscal Transparency
Special Data Dissemination Standard/
General Data Dissemination System
IMF
IMF
IMF
Financial Regulation and Supervision
Banking supervision
Securities regulation
Insurance supervision
Core Principles for Effective Banking Supervision
Objectives and Principles of Securities Regulation
Insurance Core Principles
BCBS
IOSCO
IAIS
Institutional and Market Infrastructure
Crisis resolution and deposit
insurance
Insolvency
Corporate governance
Accounting and Auditing
Payment, clearing and settlement
Market integrity
Core Principles for Effective Deposit Insurance Systems
BCBS/IADI
Insolvency and Creditor Rights
Principles of Corporate Governance
International Financial Reporting Standards (IFRS)
International Standards on Auditing (ISA)
Principles for Financial Market Infrastructures
World Bank
OECD
IASB
IAASB
CPMI (CPSS)/
IOSCO
FATF
FATF Recommendations on Combating Money
Laundering and the Financing of Terrorism & Proliferation
34
Principles for Financial Market
Infrastructures (PFMI)
•
•
•
•
The Committee on Payments and Market Infrastructures (f/k/a the Committee on Payment
and Settlement Systems) (“CPMI”) of the Bank for International Settlements and the
Technical Committee of the International Organization of Securities Commissions (“IOSCO”)
developed the PFMI.
The PFMI provide new international standards for financial market infrastructures (FMIs),
including:
– payment systems (PSs) that are systemically important;
Margin
– central securities depositories (CSDs);
– securities settlement systems (SSSs);
– central counterparties (CCPs); and
Operational
Liquidity
Risk
Risk
– trade repositories (TRs).
The PFMI also set forth five responsibilities
of central banks, market regulators and
other relevant authorities for FMIs as they
relate to the regulation, supervision and
oversight of FMIs, including, cooperation
with other authorities.
There are 24 Principles for FMIs, including
those listed to the right.
Settlement
Credit Risk
Default
Rules
35
PFMIs and QCCP Status
• A qualifying central counterparty (QCCP) is an entity that is
licensed to operate as a CCP (including a license granted by
way of confirming an exemption), and is permitted by the
appropriate regulator/overseer to operate as such with respect
to the products offered.
– This is subject to the provision that the CCP is based and
prudentially supervised in a jurisdiction where the relevant
regulator/overseer has established, and publicly indicated
that it applies to the CCP on an ongoing basis, domestic
rules and regulations that are consistent with the PFMIs.
• In addition, for a CCP to be considered a QCCP, the CCP must
make available or calculate required data for the purposes of
calculating the capital requirements for default fund exposures.
36
Basel and the QCCPs
• In December 2010 and January 2011, the Basel Committee on
Banking Supervision (BCBS) published wide ranging changes,
in line with G20 decisions, to global standards on capital and
liquidity requirements. While these standards are not binding,
they are largely adhered to in the formulation of final rules in
each jurisdiction.
• The aim of these standards is to promote a more resilient
banking system, with an improved ability for banks to absorb
shocks and a reduced level of systemic risk in the banking
sector as a whole.
• The Basel Committee on Banking Supervision’s bank capital
regime creates financial incentives for banks to clear their
financial derivatives through QCCPs, which are generally
defined as clearinghouses that are subject to rules consistent
with the PFMIs.
37
CFTC - Exempt DCOs
•
•
•
•
•
Any clearinghouse that clears swaps directly for U.S. clearing members or
indirectly for the U.S. customers of U.S. and non-U.S. clearing members must
register with the CFTC as a DCO or obtain an exemption.
The CFTC has statutory authority to exempt clearinghouses from DCO
registration if the CFTC determines that the clearinghouse is subject to
“comparable, comprehensive supervision and regulation” by the clearinghouse’s
home country regulator.
The CFTC has not yet exempted any swaps clearinghouses from registration or
proposed a way for a clearinghouse to apply for an exemption.
Recently, Staff of the CFTC’s Division of Clearing and Risk (DCR), said that the
draft of the proposed DCO rulemaking provides that in order for a clearinghouse
to be eligible for an exemption, it must, among other things, observe the PFMIs
and be organized and in good standing in a jurisdiction where the regulator
applies legal requirements consistent with the PFMIs.
However, the Staff of DCR said it intends to recommend that exempt DCOs be
prohibited from clearing for U.S. customers. This is because certain aspects of
the CFTC’s Part 22 requirements regarding the protection of client collateral for
swaps conflicts with the regulatory schemes guiding non-U.S. clearinghouses.
38
CFTC - Foreign DCOs
•
•
•
LCH.Clearnet SA (Designated as a DCO on 12/17/13)
– LCH. Clearnet SA is regulated as a clearing house by the Autorité des
Marchés Financiers (“AMF”) and as a credit institution by the Autorité de
Contrôle Prudentiel (“ACP”)
– LCH.Clearnet SA’s DCO registration contains a restriction, required by the
CFTC, to “ring-fence” swaps customer collateral, such that it can be treated
as separate from the general estate of the DCO and cannot be commingled
with other accounts. In other words, the CFTC requires foreign DCOs to
assure that US Bankruptcy law will govern a default.
Singapore Exchange Derivatives Clearing Limited (SGX-DC) (Designated as a
DCO on 12/27/13)
– SGX-DC’s DCO registration contains similar restrictions.
Comder (planned)
– Clearinghouse located in Chile which clears NDFs and IRS vanilla.
– CCP design based on BIS-IOSCO recommendation and other CCPs best
practices.
39
Collateral Conflict
≠ Bankruptcy
Law
•
•
•
•
THE ISSUE: There is a conflict between European Union (EMIR) and
U.S. rules (Dodd-Frank/CFTC) regarding the protection of client
collateral for swaps.
Swaps Collateral Model
US
Europe
LSOC (US law)
Yes
No
Omnibus Model
No
Yes
Individual Segregation
No
Yes
Swaps Trades executed on U.S. exchanges are required to clear
through CFTC-registered FCMs, which are subject to LSOC.
The CFTC could provide an exemption from LSOC for the EMIRrelated clearing models, but this would be unprecedented.
The CFTC requires foreign clearinghouses to register as a DCO with
the CFTC, with CFTC-registered FCMs as clearing members.
40
QCCP Recognition
20%
2%
≠ QCCP
• The “Collateral Conflict” has resulted in the EU delaying
recognition of the U.S. CCPs in the EU.
• Under Europe’s Basel III requirements, banks have until
December 15th to treat non-EU clearers as qualifying CCPs or
“QCCPs.”
• The QCCP designation allows the lowest risk weight of 2% for a
bank’s clearing exposures.
• After December 15th, if a CCP is not a QCCP, then the riskweights increase up to at least 20%, which means the banks
would need to dramatically increase capital.
• This is an issue because CFTC-regulated clearinghouses are
not yet recognized in the EU as equivalent - they’re not QCCPs.
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QCCP Recognition
•
•
•
•
The CFTC believes DCOs registered with the CFTC should be recognized
because CFTC regulated clearinghouses meet the international standards.
However, the EU has said in order for them to recognize US DCOs,
changes are needed in the CFTC’s treatment of clearinghouses that are
located in Europe, but are also registered with the U.S. The EC cites EMIR
as the reason for such as a decision because EMIR requires a reciprocal
regime of a foreign entity for authorizing European and other third-country
clearers in order to grant an equivalency determination.
According to Chairman Massad, the CFTC and Europeans are working to
have DCOs recognized overseas. Chairman Massad recently stated that
the CFTC is looking at whether the CFTC can further harmonize its rules.
As a result of this work, the European Commission postponed the
imposition of higher capital charges on European banks participating in
CFTC registered DCOs.
The CFTC has not yet issued its rule on exempt DCOs, but the CFTC
indicated that those rules would prohibit foreign clearinghouses from
accepting US clients. As noted above, the rules currently only allow a nonUS CCP that is fully registered as a DCO to clear for US clients.
42
QCCP Recognition
•
On October 30, 2014, the EC announced its first “equivalence” decisions for the
regulatory regimes of CCPs in Australia, Hong Kong, Japan and Singapore:
Globally agreed reforms of derivatives markets – like all financial services
reforms – will only work in international markets if regulators and supervisors
rely on each other. Today's decisions show that the EU is willing to defer to the
regulatory frameworks of third countries, if they meet the same objectives as
EU rules. We have been working in parallel on assessing twelve additional
jurisdictions and finalising those assessments is a top priority. This includes the
United States: we are in close and continued dialogue with our colleagues at
both the SEC and CFTC as we develop our assessments of their respective
regimes and discuss their approaches to deference.
Equivalence
Equivalence Pending
43
KEY ATTORNEY PROFILES
ATTORNEY PROFILE
STEPHEN M. HUMENIK
Of Counsel
shumenik@cov.com
Covington & Burling LLP
1201 Pennsylvania Avenue, NW
Washington, DC 20004-2401
Tel: 202.662.5803
Stephen Humenik leads the firm’s futures and derivatives practice. He has
extensive experience on regulatory and enforcement matters involving the
CFTC and the derivatives and commodities markets. Specifically, Mr.
Humenik advises clients on regulatory and policy matters relating to the
registration and compliance obligations of the Dodd-Frank Act and
represents clients in CFTC enforcement investigations and proceedings.
Prior to joining Covington, Mr. Humenik was general counsel and chief
regulatory officer of Eris Exchange, LLC, an interest rate swap derivatives
market, where he oversaw the legal and regulatory affairs of the exchange,
including the exchange’s designation as a contract market and ongoing
compliance with CFTC regulations. Mr. Humenik previously served as Special
Counsel and Policy Advisor to Commissioner Scott O’Malia where he assisted
on rulemaking, enforcement and legislative matters. Mr. Humenik began his
career at the CFTC and primarily served as Senior Trial Attorney for the
CFTC’s Division of Enforcement where he investigated and litigated complex
fraud and market manipulation cases, specifically those involving energy and
financial derivatives and physical commodities. Mr. Humenik also practiced
in the SEC enforcement group of a law firm in Washington, DC.
45
ATTORNEY PROFILE
CHARLOTTE HILL
Partner
chill@cov.com
Covington & Burling LLP
265 Strand
London WC2R 1BH
Tel: 44.(0)20.7067.2190
Charlotte Hill is a financial services and regulation partner in the London
office. She specialises in advising financial institutions on regulatory
and commercial matters.
Ms. Hill has had considerable industry experience during her career,
having worked at the regulator, IMRO (a predecessor regulator of the
FCA) in the enforcement division and subsequently, was Director of
Legal at Threadneedle Investments. This industry experience is
invaluable in providing clients with truly commercially focused advice.
Ms. Hill's clients range from very large, multi-national conglomerates to
specialist boutiques.
Ms. Hill has been recognised as a Leading Individual by Chambers UK
since 2010, who note “her in-depth knowledge of the FSA” and
“professional, responsive” approach, as well as Legal 500 UK (20102013).
Ms. Hill regularly publishes articles on regulatory topics in a range of
industry publications and speaks at both external conferences and
seminars and in-house client training events.
46
ATTORNEY PROFILE
BRUCE C. BENNETT
Partner
bennett@cov.com
Covington & Burling LLP
The New York Times Building
620 Eighth Avenue
New York, NY 10018-1405
Tel: 212.841.1060
Bruce Bennett is head of the financial services institution group at
Covington, resident in the New York office. Mr. Bennett's practice
focuses on domestic and international capital markets transactions,
including equity, equity-linked and fixed income (high yield and
investment grade) offerings. He also regularly represents participants in
structuring and executing a wide range of derivatives transactions, as
well as with respect to related ISDA documentation. In addition to his
transactional practice, Mr. Bennett advises clients on regulatory and
policy matters affecting the capital markets, with particular focus on the
Dodd-Frank Act and related regulations. He regularly represents clients
on interpretive issues before the Securities and Exchange Commission,
the Commodity Futures Trading Commission and other regulatory
agencies. Mr. Bennett is also a frequent speaker at corporate and
securities law seminars and regularly publishes in these fields.
47
ATTORNEY PROFILE
JOHN DUGAN
Partner
jdugan@cov.com
Covington & Burling LLP
1201 Pennsylvania Avenue, NW
Washington, DC 20004-2401
Tel: 202.662.5051
John Dugan formerly Comptroller of the Currency from 2005-10, is a partner
in the firm’s Washington, DC office and chairs the firm’s Financial
Institutions Group. He advises clients on a range of legal matters affected by
significantly increased regulatory requirements resulting from the financial
crisis, including implementation of the Dodd-Frank Act; financial institution
mergers, acquisitions, and investments; litigation and enforcement issues;
international financial regulation; and legislative and government relations
issues.
As Comptroller, Mr. Dugan headed the agency that supervises over 1,500
national banks and federal branches of foreign banks, which together hold
nearly two-thirds of the assets of the US commercial banking system. He also
served on the Board of Directors of the Federal Deposit Insurance
Corporation. During his five-year term, Mr. Dugan led the Office of the
Comptroller of the Currency (OCC) through the financial crisis and ensuing
recession that resulted in extraordinary regulatory and supervisory actions
for national banks of all sizes, including government assistance provided
under the Troubled Asset Relief Program (TARP); resolutions of large, midsize, and community banks; and the successful implementation of regulatory
“stress tests.”
Before serving as Comptroller, Mr. Dugan was a partner in the firm,
specializing in financial institution regulatory matters from 1993-2005. He
had previously served at the U.S. Department of the Treasury from 1989 to
1993, where he was appointed Assistant Secretary for Domestic Finance
and had extensive responsibility for policy initiatives involving banks and
financial institutions, including the savings and loan cleanup, Glass-Steagall
and banking reform, and regulation of government-sponsored enterprises.
48