OTC Derivatives Markets Act of 2009

Transcription

1 OTC Derivatives Markets Act of 2009 November 10, 2009 Glenn Sarno, Joyce Xu and Daniel Bae

2 OTC DMA Overview Over-the-Counter Derivatives Markets Act of 2009 Highlights Establishes framework for comprehensive regulation of OTC derivatives; Divides regulatory authority over OTC derivatives between the CFTC and the SEC; Requires central clearing and exchange trading for specified swaps; Regulation of clearing and trading facilities: exchanges, swap execution facilities, derivatives clearing organizations and "swap repositories."

3 OTC DMA Overview Over-the-Counter Derivatives Markets Act of 2009 Highlights (cont d) Requires registration of new classes of regulated entities - swap dealers, security-based swap dealers, major swap participants, and major security-based swap participants - with the CFTC and/or the SEC; Establishes framework for setting requirements for the regulated entities with respect to margin, position limits and segregation of funds and collateral; Brings security-based swaps under the definition of "security ; Establishes disclosure, reporting and recordkeeping requirements for all swaps.

4 Division of Regulatory Power CFTC Swaps (Non-security based) SEC Security-Based Swaps

5 OTC DMA Certain New Definitions "Swap" An agreement, contract, or transaction that is: (i) an option or other contract involving exchange of payments that is linked to, among other things, interest rates, currencies, securities, commodities, instruments of indebtedness, and quantitative measures; (ii) event-based contract contract providing for purchase, sale, payment or delivery dependent on event or contingency associated with a potential financial, economic or commercial consequence; (iii) commonly known to the trade as a swap; or (iv) any combination or permutation of the above.

6 OTC DMA Certain New Definitions "Swap" Exclusions: listed commodity forwards/futures and security futures; physically settled non-financial commodity forwards/futures; an option on a security that is subject to the Securities Act or the Exchange Act; Exchange-traded foreign currency options; An agreement providing for the purchase of sale of one or more securities on a fixed basis that is subject to the Securities Act and the Exchange Act; Contingent physically settled, contract for sale of securities that is subject to the Securities Act and the Exchange Act, but not an eventbased contract where the contingency is based on the credit worthiness of third party a note, bond or other evidence of indebtedness that is a security as defined in the Securities Act; any agreement that is based on a security and entered into directly or through an underwriter (as defined in the Securities Act), by the issuer of the security for the purposes of managing a risk associated with capital raising; foreign-exchange swaps and forwards; an agreement with the U.S. government or a Federal Reserve Bank; or a Security-Based Swap; other than Mixed Based Swaps which are both Swaps and Security-Based Swaps

7 OTC DMA Certain New Definitions "Security-Based Swap" Any agreement, contract, or transaction that would be a Swap and that 1. is based on a narrow-based security index; 2. is based on a single security or loan; or 3. is a CDS linked to a single issuer of a security or the issuers of securities in a narrow-based security index. Exclusion does not include a swap referencing a U.S. government security.

8 OTC DMA Certain Amended Definitions "Security" the definition of "Security" in the Securities Act and the Exchange Act is expanded to include "Security-Based Swap". Repeal of prohibition on certain regulation of Security- Based Swaps (Section 206B of Gramm-Leach-Bliley Act) "sale" or "offer" - any offer or sale of security-based swap by or on behalf of (1) the issuer of the underlying securities, (2) its affiliate or (3) an underwriter, shall constitute a sale or offer for sale of such underlying securities "purchase" or "sale" with respect to a security-based swap, means the execution, early termination, assignment, exchange or similar transfer or conveyance of, or extinguishing of rights or obligations under, a security-based swap

9 OTC DMA Amendments to the Securities Act Registration Requirement - Registration Requirement extends to offer and sale of Security-Based Swap (and to the underlying securities if offered or sold by issuer/affiliate/underwriter of the underlying securities); Exemptions under Section 3 and Section 4 of the Securities Act not available to offer to sell, sale of, offer to buy or purchase of a security-based swap to or from a non-ecp. Additions of Security-Based Swaps to Certain Enforcement Actions Section 9 of the Securities Exchange Act amended to include Security-Based Swaps.

10 OTC DMA - Beneficial Ownership Section 13 and Section 16 of the Exchange Act Beneficial Ownership now includes ownership of the securities underlying a security-based swap if the swap is determined by the SEC, after consultation with the Prudential Regulators and Treasury Secretary, to provide "incidents of ownership comparable to direct ownership of the equity security".

11 OTC DMA Clearing Requirement Swaps/Security-Based Swaps accepted by a DCO/CA and approved by the CFTC/SEC must be cleared Swaps - Derivatives Clearing Organization ("DCO") Security-Based Swaps - a Clearing Agency ("CA") In granting the approval, the CFTC and the SEC shall take into account: the existence of significant outstanding notional exposures, trading liquidity and adequate pricing data; the availability of swap clearinghouses with ability to clear the contract on terms that are consistent with the material terms and trading conventions on which the contract is then traded; the impact on the mitigation of systemic risk; the impact on competition; and the existence of reasonable legal certainty in the event of the insolvency of the relevant swap clearinghouse with regard to the treatment of customer and swap counterparty positions, funds, and property.

12 OTC DMA Clearing Requirement Exceptions to the Clearing Requirement (A) no DCO registered under this Act will accept the trade for clearing; or (B) one of the counterparties to the Swap is not a Swap Dealer or Major Swap Participant.

13 OTC DMA Clearing and Reporting Reporting of Non-Cleared Trades If a DCO or a CA does not accept the transaction for clearing report to a Swap Repository or a Security- Based Swap Repository, respectively. If a Swap Repository or a Security-Based Swap Repository does not accept the transaction report to the CFTC or the SEC, respectively.

14 OTC DMA Clearing and Reporting Working Towards More Transparency Types of information Regulators OTC derivative transactions and open positions of market participants Public aggregated data on open positions trading volumes Sources of information Derivatives Clearing Organizations; Clearing Agencies; and Swap & Security-Based Swap Repositories.

15 OTC DMA New Regulated Institutions for Clearing Derivatives Clearing Organizations ("DCO") & Clearing Agencies ("CA") Reporting requirement all information determined by the CFTC or the SEC, as the case may be, to be necessary to perform its responsibilities under this Act. Registration requirement DCOs must register with the CFTC; CAs must register with the SEC.

16 OTC DMA New Regulated Institutions for Clearing Derivatives Clearing Organizations ("DCO") & Clearing Agencies ("CA") Additional principles 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; anti-trust considerations; governance fitness standards; legal risk.

17 OTC DMA New Regulated Institutions for Trade Reporting Swap Repositories ("SR") & Security-Based Swap Repositories ("SBSR") for OTC Derivatives (Nonexchange Traded) Duties accept data on swaps; maintain such data; provide to the CFTC or the SEC such information; publish data for the public, in aggregate form, in a manner that does not disclose the business transactions and market positions of any person.

18 OTC DMA New Regulated Institutions for Trade Reporting Swap Repositories ("SR") & Security-Based Swap Repositories ("SBSR") for OTC Derivatives (Nonexchange Traded) Registration requirement SRs must register with the CFTC; SBSRs must register with the SEC; Exemption if such SR or SBSR is subject to comparable comprehensive supervision and regulation on a consolidated basis by the CFTC, the SEC, a Prudential Regulator, or the appropriate governmental authorities.

19 OTC DMA Exchange Trading Swap or Security-Based Swap transactions that are required to be cleared must be executed on regulated exchange; swap execution facility; alternative swap execution facility. Exceptions Not listed on a regulated exchange or execution facility, or one of the counterparties to the Swap/Security-Based Swap is not a Swap Dealer or Major Swap Participant/Security-Based Swap Dealer or Major Security-Based Swap Participant.

20 OTC DMA New Regulated Entities for Exchange Trading Swap Execution Facilities ("SEFs") & Alternative Swap Execution Facilities ("ASEFs") Swaps may be traded on regulated SEFs and on regulated futures exchanges Security Based Swaps may be traded on regulated ASEFs and regulated national securities exchanges. Reporting requirement Must provide all information determined by the CFTC or the SEC, as the case may be, to be necessary to perform its responsibilities under this Act. Registration requirement SEFs must register with the CFTC; ASEFs must register with the SEC.

21 OTC DMA New Regulated Entities for Exchange Trading Swap Execution Facilities ("SEFs") & Alternative Swap Execution Facilities ("ASEFs") Criteria for registration (i) trading rules; (ii) procedures to monitor improper trading; (iii) clearance and settlement; (iv) ability to obtain information and willing to provide information to regulators; (v) set position limits; (vi) publish trading information. Exemption if such SEF or ASEF is subject to comparable comprehensive supervision and regulation on a consolidated basis by the CFTC, the SEC, a Prudential Regulator, or the appropriate governmental authorities.

22 OTC DMA Enhanced Regulation of Derivatives Dealers and Market Participants Entity Regulator Swap Dealers & Major Swap Participants Commodity Futures Trading Commission ("CFTC") Security-Based Swap Dealers & Major Security-Based Swap Participants Securities and Exchange Commission ("SEC")

23 OTC DMA Definitions for New Regulated Entities "Swap Dealer" any person engaged in the business of buying and selling Swaps for such person s own account, through a broker or otherwise. "Security-Based Swap Dealer" any person engaged in the business of buying and selling Security-Based Swaps for such person s own account, through a broker or otherwise. Exception does not include a person that buys or sells Swaps or Security-Based Swaps (as the case may be) for such person s own account, either individually or in a fiduciary capacity, but not as a part of a regular business.

24 OTC DMA Definitions for New Regulated Entities "Major Swap Participant" any person who is not a Swap Dealer and who maintains a substantial net position in outstanding Swaps (excluding positions held primarily for hedging or risk management purposes). "Major Security-Based Swap Participant" any person who is not a Security-Based Swap Dealer and who maintains a substantial net position in outstanding Security-Based Swaps (excluding positions held primarily for hedging or risk management purposes). "Substantial Net Position" threshold to be jointly set by the CFTC and the SEC.

25 OTC DMA New Regulated Entities- Registration Requirements Swap Dealers & Major Swap Participants Must register with the CFTC. Dual Registration no bank exemption must register with the CFTC even if also a bank; must register with the CFTC even if also registered with the SEC as a Security-Based Swap Dealer or a Major Security-Based Swap Participant. Exemptions The CFTC would be permitted to exempt "only as expressly authorized".

26 OTC DMA New Regulated Entities- Registration Requirements Security-Based Swap Dealers & Major Security- Based Swap Participants Must register with the SEC. Dual Registration no bank exemption must register with the SEC even if also a bank; must register with the SEC even if also registered with the CFTC as a Swap Dealer or a Major Swap Participant. Exemption The SEC would be permitted to exempt "only as expressly authorized". Security-Based Swap Dealers & Major Security- Based Swap Participants subject to substantially similar requirements as brokers or dealers.

27 OTC DMA New Regulated Entities- Prudential Regulator The Board of Governors of the Federal Reserve System (the "Fed") if the Entity is: a State-chartered bank that is a member of the Federal Reserve System; or a State-chartered branch or agency of a foreign bank; The Office of the Comptroller if the Entity is: a national bank; or a federally chartered branch or agency of a foreign bank; The Federal Deposit Insurance Corporation (the "FDIC") if the Entity is not a member of the Fed.

28 OTC DMA New Regulated Entities- Regulatory Capital Requirements Banks Prudential Regulators stricter requirements for non-cleared Bank Swaps than for cleared Bank Swaps Bank Holding Companies The Fed as strict or stricter than the capital requirements set by the Prudential Regulators for the Banks All other registered entities The CFTC and the SEC as strict or stricter than the capital requirements set by the Prudential Regulators for the Banks

29 OTC DMA New Regulated Entities- Margin Requirements Banks Prudential Regulators initial and variation margin requirements not required if one of the parties is not a swap dealer, major swap participant, security-based swap dealer or major security-based swap dealer All other registered entities The CFTC and the SEC as strict or stricter than the margin requirements set by the Prudential Regulators for the Banks.

30 OTC DMA New Regulated Entities Segregation of Funds Segregation of funds Cleared Derivatives - Must segregate, maintain and use funds or property held as collateral or margin in accordance with rules set by the CFTC, SEC or Prudential Regulator. Non-cleared Derivatives If requested by the counterparty, swap dealers must segregate funds or property held as collateral or margin Independent third party custodian required Individually negotiated business arrangements regarding investment of segregated funds not prohibited

31 OTC DMA New Regulated Entities Reporting & Disclosure Requirements Swap Dealers, Major Swap Participants, Security- Based Swap Dealers, & Major Security-Based Swap Participants shall disclose: (A) terms and conditions of its swaps & securitybased swaps; (B) swap & security-based swap trading operations, mechanisms, and practices; (C) financial integrity protections relating to swaps & security-based swaps; and (D) other information relevant to its trading in swaps & security-based swaps.

32 OTC DMA New Regulated Entities Other Regulatory Requirements Books and Records; Recordkeeping; Reports: The CFTC and the SEC shall make rules to establish books and records requirements. Business Conduct: The CFTC and the SEC shall make "Business Conduct" rules.

33 OTC DMA New Regulated Entities Other Regulatory Requirements Documentation and Back Office Standards: The CFTC and the SEC shall make rules addressing timely and accurate confirmation, processing, netting, documentation, and valuation of all security-based swaps. Conflicts of Interest: Registrants shall implement conflict-of-interest systems and procedures that partition information between research or analysis of the price or market and clearing and trading.

34 OTC DMA Joint Rulemaking Uniform Rules Rules and regulations prescribed jointly under this Act by the CFTC and the SEC shall be uniform. Treasury If the CFTC and the SEC fail to make a uniform rule in a timely manner, Treasury will step in and make a rule. Treasury s rule will remain in effect until the CFTC and the SEC agree on a uniform rule. Similar Products The CFTC and the SEC shall treat functionally or economically similar products similarly. Joint Interpretation Any interpretation of this Act shall be effective only if issued jointly by the CFTC and the SEC if this Act requires the CFTC and the SEC to issue joint regulations.

35 The Current State of Play Date Proposal Proposed By / Approved By TBD (This Week) Over-the-Counter Derivatives Markets Act of 2009 Sen. Dodd, Senate Banking Committee October 21, 2009 October 16, 2009 Over-the-Counter Derivatives Markets Transparency and Accountability Act of 2009 A Joint Report of the SEC and the CFTC on Harmonization of Regulation Approved, House Agriculture Committee CFTC and SEC October 15, 2009 Over-the-Counter Derivatives Markets Act of 2009 Approved, House Financial Services Committee October 2, 2009 Draft OTC Derivatives Legislative Proposal Barney Frank proposed draft August 11, 2009 Over-the-Counter Derivatives Markets Act of 2009 Treasury proposed bill July 30, 2009 The Frank-Peterson Principles Collin Peterson and Barney Frank June 17, 2009 May 13, 2009 Financial Regulatory Reform: A New Foundation: Rebuilding Financial Supervision and Regulation Congressional Letter: Over-The-Counter Derivatives Treasury White Paper Treasury March 24, 2009 CFTC Concept Release CFTC

36 Harmonization Separate Regulatory Regimes Why are there separate regulatory regimes? Securities Markets primary concern capital formation; disclosure. Futures Markets primary concern risk management and allocation. Derivatives neither agency has had the authority to regulate; significant regulatory gaps.

37 Harmonization Separate Regulatory Regimes Focus of SEC and CFTC Joint Report review and analyze the current statutory and regulatory structure for the SEC and the CFTC in the following areas: (i) product listing and approval; (ii) exchange/clearinghouse rule changes; (iii) risk-based portfolio margining and bankruptcy/insolvency regimes; (iv) linked national market and common clearing versus separate markets and exchange-directed clearing; (v) price manipulation and insider trading; (vi) customer protection standards applicable to financial advisers; (vii) regulatory compliance by dual registrants; and (viii) cross-border regulatory matters.

38 Harmonization Suggestions Summary Balance the opportunity to comment (SEC) vs. the speed provided by selfcertification (CFTC). Risk-based portfolio margining. Further modifications to portfolio margining, including adoption of a one account model that would accommodate all financial instruments and all broker-dealers and FCMs Enhance CFTC authority over exchange and clearinghouse compliance with the CEA. Legislation that would impose a uniform fiduciary duty on intermediaries who provide similar investment advisory services regarding futures or securities. The CFTC and the SEC should review regulatory requirements applicable to investment advisers and commodity trading advisors/commodity pool operators with respect to private funds to eliminate any inconsistent or conflicting provisions. Legislation should be enacted to encourage whistleblowers to come forward with relevant information to authorities in both SEC and CFTC registered markets. Legislation to expand the scope of insider trading prohibitions under the CEA. Expanding the SEC s statutory authority to allow the SEC to bring actions for aiding and abetting violations of the Securities Act and the Investment Company Act would close the gap between the SEC and CFTC s regulatory regimes.

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