North American Power Credit Organization

Transcription

1 North American Power Credit Organization Practical considerations associated with the Dodd-Frank Act (3:15pm 5:00pm) 2 May 2013

2 Agenda and contents Dodd-Frank overview and highlights 3-6 Industry snapshot Top 5 readiness challenges that are top of mind 8 Select rule topic areas impacting end-users 9-10 Electing the end-user exception to clearing 11 Honing in on the credit function Implications to the credit function 13 Page 2

3 Overview of the Dodd-Frank Act Title VII OTC derivatives On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted imposing the most significant financial regulation in the U.S. since the Great Depression. As a result, Title VII of the Dodd-Frank Act was introduced as the regulatory regime for the OTC derivatives market changes have resulted in increased: Participant level obligations Routine analysis Transaction cycle controls Data requirements Governance and compliance Difference in market treatment Transacting bilateral swaps versus futures Executing cleared versus uncleared transactions Enumerated contracts Potential penalties Good faith defense may be limited Civil Criminal Compliance timeline: Implementation timeframe Minimum of 60 days to 270 days depending on entity type and specific rule topic area Page 3

4 Entity designation impacts Swap Dealers (SDs) and Major Swap Participants (MSPs) face the heaviest compliance burden; includes formal registration and ongoing business conduct requirements Financial entities and nonfinancial speculators are subject to new mandatory clearing and trading requirements Exception from clearing for some nonfinancial end-users (or non-sd/msps), but the exception is transaction specific and is limited Highest impact Swap Dealer Major Swap Participant Firms that sell / deal / make market in derivatives beyond a de minimis notional volume over the past 12-months Firms with a substantial position in speculative derivatives and/or substantial counterparty exposure on all derivatives, including those that qualify as hedges Financial Entity Includes SDs and MSPs, funds, banks, insurers, pensions, or any firm predominantly engaged in financial activities Lowest impact Nonfinancial or Commercial End-users Nonfinancial end-users of derivatives that are privy to the end-user exception from mandatory clearing requirements Page 4

5 Regulatory landscape is continuously evolving The CFTC s rulemaking continues to focus on enhancing regulatory oversight and increasing transparency of executed swap transactions; irrespective of entity designation. Key objectives Enhanced regulatory oversight Regulatory requirements Registration requirements for dealers and other major market participants Central clearing requirements Margin / collateral requirements for non-cleared swaps Capital adequacy requirements for non-cleared swaps Increased transactional transparency Recordkeeping and reporting Real-time reporting Trading requirement (could potentially apply to any swap subject to clearing requirement) Implementation obstacles Rule-making still in progress; extensions and delays continue Significant systems, process and behavioral changes across the transaction lifecycle Overlapping regulation and requirements Page 5

6 Select implementation challenges As companies are trying to keep pace with the finalization of regulatory reform rulings, several have realized the significant challenges involved in implementation. Below are common implementation hurdles to consider: Rule confusion Timing uncertainty Challenges: Rules are complex and, at times, self-contradictory Rules are, to be generous, inadequately defined to implement Conflicting definitions and terminology from various regulatory agencies Rule compliance deadlines have been subject to just in time deferral Transaction/Company designation creates staggered compliance timeframes Gap identification Identifying the implication of differing definitions and interpretations of hedging Understanding needed process and technology enhancements Stakeholder engagement Cost considerations Establishing clear accountability and cross-functional ownership Modification of existing policies and procedures to govern new operational activities Determining the appropriate compliance implementation spend and effort Interim versus final state solution includes consideration of automated versus resource intensive based solution Page 6

7 Industry snapshot Page 7

8 Top 5 readiness challenges that are top of mind Market participants are currently operating at various levels of readiness for their Dodd-Frank programs; nonetheless, items highlighted below are routinely brought up in conversation. Understanding implications of operating nuances across the transaction lifecycle Establishing the appropriate control infrastructure, defining roles and responsibilities, and enabling effectiveness without compromising data quality includes maintaining accountability Developing a transparent and effective campaign to socialize and obtain buy-in of new operating protocols Defining new and/or revising existing policies and procedures for managing transactions that fall under the purview of the Dodd-Frank Act - includes communication and training Navigating through system limitations Capturing, tracking and reporting of new required data elements in a timely manner - includes deriving a tactical method to meet compliance needs while industry standards are established Management of new referential terms with counterparties Receipt and representation of referential and dynamic data attributes required for PET data submission (reporting) and recordkeeping - includes "getting to know your counterparty, better" Determination of which SDR to utilize Establishing data submission strategy (i.e., manual vs. automated submission through API) Clearly understanding data submission requirements required by the selected SDR (one size does not fit all) Page 8

9 Select rule topic areas impacting end-users (1 of 2) Entity designation determination and monitoring Documentation and performance of routine de minimis and MSP (or safe harbor) calculations Controls established to track exposure against special entity thresholds (i.e., $25m and $800m) Registration of legal entity identifier (LEI) or CFTC Interim Compliant Identifier (CICI) Handling of inter-affiliate transactions Commodity options Formal review procedure(s) established for transactions that would potentially be subject to forward contract exclusion and commodity option tests Assignment of accountability and documentation standard at both pre- and post-execution Confirmation of trade option status with counterparties for historical and prospective transactions Swap trading relationship between swap dealers and their counterparties All OTC swap counterparties that are currently using ISDA Master Agreements or other swap agreements with Swap Dealers will be required to supplement such swap agreements so that SDs can comply with the Dodd Frank requirements (e.g., ISDA Protocol and IECA DF Supplement) If end-user counterparties do not update and/or supplement existing agreements, the SD may potentially no longer be legally permitted to execute new transactions with that counterparty Page 9

10 Select rule topic areas impacting end-users (2 of 2) Recordkeeping (Part 45 and 46) Retention of full, complete and systematic records with respect to executed swap transactions Re-configuration of business processes and existing application architecture to capture, record and retrieve all required primary economic terms (or PET data) Assignment of accountability to record new data elements at the time of and after deal execution (e.g., time stamp and USI) Reporting (Part 45 and 46) Formal determination and agreement of reporting party for historical and prospective transactions Selection and testing of trade submission to a swap data repository (or SDR) Processing of continuation data and lifecycle events includes identification and reporting timeline Election of the end user exception Establishing procedures to obtain board level approval for the decision to enter into uncleared swap transactions includes compliance with stated requirements for electing the exception Ability to capture new data elements specific to non-sd/msp counterparties that are electing to bypass the clearing mandate (i.e., when acting as the reporting party) Page 10

11 Electing the end-user exception to clearing The Dodd-Frank Act calls for the mandatory clearing of all swaps that the CFTC determines must be cleared, unless the "end-user exception is elected (certain restrictions apply). Educating management and the board of directors (BoD): Management and/or the BoD must understand the impact of Title VII and new responsibilities Corporate governance: The BoD must pass a resolution to give the appropriate committee authority to review and approve the decision to enter into clearing-exempt swaps Initial and annual review: The appropriate committee must review and approve the decision to enter into clearing-exempt swaps on an at-least annual basis and when entering into a new hedging strategy (as applicable) Annual filing: The company must submit a notification to the CFTC regarding how it qualifies for the end-user exception Trade-by-trade election of the exception: The company must qualify for and elect the end-user exception on a trade-by-trade basis End-user fast facts Not a "financial entity" Using swaps to hedge or mitigate commercial risk Notifies the CFTC as to how it generally meets its financial obligations associated with entering into un-cleared swaps The Reporting counterparty to the swap is required to report details to support the end-user exception to a registered SDR or directly to the CFTC Page 11

12 Honing in on the credit function Page 12

13 Implications to the credit function As the evolution of the Dodd-Frank Act continues and enhanced clarity is ascertained on the operational impacts across the transaction lifecycle; the credit function will continue to be effected moving forward. Background: Given the uncertainty of regulations and challenges associated with adhering to certain rule topic areas, certain market participants have navigated towards executing solely futures transactions As the market transitions to screen based trading or futures, the potential for the bid / offer spread in bilateral markets will continue to widen due to lack of liquidity and/or market depth Moving forward: Market participants will need to routinely evaluate the cost / benefit of executing futures transactions versus utilizing existing lines of bilateral counterparty credit that have been made available to them Enhanced policies and procedures will be required to govern, monitor and report working capital and liquidity thresholds due to higher draws on cash for margining purposes (both in- and out-flows) Greater need for analytics and margining transparency to monitor and report working capital at risk to senior management For more robust transactional activities, credit decision making will need to be more closely integrated with trade execution Page 13

14 Our team Page 14

15 Thomas (Tom) Lord Executive Director Direct Tel: Mobile: Background Professional experience Tom is an Executive Director within Ernst & Young s Financial Accounting Advisory Services (FAAS) practice. He has more than 35 years of leadership experience in the energy sector with a focus on the business development, marketing, trading, compliance, regulatory affairs and risk control segments of the industry. His latest focus has been the strategy, process change and implementation requirements for adopting increasingly sophisticated trade surveillance monitoring infrastructure for oversight of futures, swaps and physical trading in commodity markets. MS Mechanical Engineering and BA Government Cornell University JD University of Denver Sturm College of Law Skills Strategic advisory services to commodity market participants from business strategy to private equity negotiation to all phases of transactional activity both bespoke and open market to risk and compliance management and exit strategy formation and due diligence. Industry expert in financial transaction regulation of commodity markets (Dodd Frank and other structures) and trade surveillance Market design and analysis including option based market oversight structures Trading, transaction and hedging operations Led a boutique firm focused on providing Dodd- Frank assessment, gap analysis and implementation services for commodity (energy, agriculture and metals) firms as well as providing assistance to law firms and other consulting firms in this area Led development of OTC derivatives regulatory response effort in the commodity marketplace Participated in financial services working groups on derivatives regulation, OTC reporting, OTC risk management and non-fs end-user impacts Launched practice area for commodity firm Dodd-Frank compliance advisory services for a Big Four firm Provided subject matter knowledge to design multiple models to implement an energy trade surveillance compliance product launch responding to CFTC, CME and FERC regulations and oversight activities for a leading supplier of trade surveillance compliance software Authored a $21 million equity financing offer for an ethanol client and provided a business plan and logistics investment plans for four ethanol facilities Directed the development, design, delivery and implementation of custom transaction capture and position software for major NE IOU natural gas desk Created generation and staff skill asset investment strategy for a major Mid-Atlantic region IOU in emerging wholesale power markets Led a off-take hedging transaction origination and execution for 35-million-gallon-a-year biodiesel operation, including domestic and European biodiesel sales and US and Indonesian vegetable oil purchases Page 15

16 Abdullah Khan Senior Manager Direct Tel: Direct Fax: Mobile: abdullah.khan@ey.com Background Professional experience Skills Abdullah is a Senior Manager in the Assurance Practice of Ernst & Young, LLP in Houston with over 14 years of experience in the utilities, financial services and oil and gas industries. Has advised clients in the areas of Dodd-Frank, financial re-engineering, valuation, ETRM vendor selection and implementation, due diligence, regulatory compliance, and business process redesign and control development in North America, Europe and the Middle East. Abdullah has a BBA in Finance and Marketing from the University of Houston and a MBA (concentration in Finance and Accounting) from the University of St. Thomas. Dodd-Frank Assessment and Implementation Business Transformation and Process Redesign Design and Testing of Financial Controls M&A Due Diligence and Valuation Bankruptcy Proceedings Trading & Risk Management System Implementation Commodities Experience: Physical and Financial Power, Natural Gas, Metals, and Crude and Refined Products Led the Dodd-Frank implementation effort at a large independent power producer. Key activities included: assistance with the entity designation analysis and performing a high-level gap analysis based on specific requirements for Title VII of the Act included the development of a heat map to assess impacts to current operating model. Led the global financial re-engineering initiative for commodity trading activities at a large investment bank. Performed a gap analysis of mid- and backoffice operations by identifying requirements for process improvement, highlighting various corporate metrics. Created a future state operating model and a prioritized recommendation roadmap with calculated benefits. Led the vendor selection and evaluation process for a major US utility's initiative to replace the firm's Gas Management System. Key activities included: developing cross functional business and technical requirements, vendor demo scripts, objective selection criteria and vendor scorecard. Conducted a strategic cross functional and IT assessment at a major US utility to maximize efficiency across the company s energy trading operations. Key deliverables included: a benchmark of current state activities against industry leading practices, a future state roadmap for power and gas trading activities, and a prioritized five year IT implementation blueprint. Managed the visioning and roadmap initiative at a large investment bank for its global commodities operation to help support the business case for product diversification, revenue growth and a planned increase in market presence for physical transactions. Led the implementation of a future state roadmap at a major US utility. Primary activities included: the remediation of tactical pain points across the front-, middle- and back-offices, the implementation of an operational data store to enhance data transparency and centralize reporting, and the documentation of business and technical requirements for the replacement of a legacy Gas Management System Participated in the accelerated integrated design effort for a large OpenLink Endur implementation at a multinational oil company. Primary activities included the functional and technical design documentation for the middle-office, settlements and accounting. Conducted the valuation of proposed wholesale and retail termination and settlement agreements of energy-based derivative contracts in connection with a large U.S. bankruptcy filing for the Unsecured Creditors Committee. Commodities analyzed included physical and financial gas, power, pulp and paper, and oil products. Page 16

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