EDF TRADING A leader in the international wholesale energy market 27 February 2012
The Dodd-Frank Act Overview The Commodities Futures Trading Commission (CFTC) The Dodd-Frank Act What is it? What does it mean? Definitions and designations Position Limits Potential impacts What s next? 2
The CFTC There are five CFTC Commissioners. The commissioners are appointed by the President with confirmation by the Senate. Commissioners serve five-year terms. No more than three commissioners may be from the same political party, at any one time. Chairman Gary Gensler (D) Sworn in on May 26, 2009. Commissioner Jill Sommers (R) Sworn in on August 8, 2007. Second term began in 2009. Commissioner Bart Chilton (D) Sworn in on August 8, 2007. Second term began in 2009. Commissioner Scott O Malia (R) Sworn in on October 8, 2009. Commissioner Mark Wetjen (D) Sworn in on October 25, 2011. 3
The Dodd-Frank Act What, Why and How? The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was signed into law by President Obama on July 21, 2010. Title VII of Dodd-Frank has the most significant impact on the energy sector. The intent of Dodd-Frank is to establish a regulatory framework for swaps and security-based swaps to reduce systemic risk, increase market transparency and increase financial stability. How will this be accomplished? Registration and comprehensive legislation of swap dealers (SDs) and major swap participants (MSPs). Clearing and trade execution requirements on standardized derivative products. Moving the OTC derivatives market onto regulated clearing exchanges. Implementing and increasing recordkeeping and real-time reporting requirements. Enhancing the Commodity Futures Trading Commission s (CFTC) rulemaking and enforcement authorities. 4
Dodd-Frank Definitions What is a swap? The definition of swap is very broad and includes a wide variety of agreements, contracts and transactions. Under Dodd-Frank, the term swap means any agreement, contract, or transaction- that is a put, call, cap, floor, collar, or similar option of any kind that is for the purchase or sale, or based on the value, of 1 or more interest or other rates, currencies, commodities, securities, instruments of indebtedness, indices, quantitative measures, or other financial or economic interests or property of any kind; that provides for any purchase, sale, payment, or delivery (other than a dividend on an equity security) that is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence. There is an exclusion for forward contracts. The swap definition excludes any sale of a nonfinancial commodity for deferred shipment or delivery, so long as it the transaction is intended to be physically settled. 5
Dodd-Frank Update The General Rules All swaps that can be cleared, must be cleared. All swaps that can be traded on an exchange, must be traded on an exchange. All swaps, cleared and uncleared, shall be reported to a swap data repository (SDR) or to the CFTC if SDRs will not accept the swap. Current registered SDRs in the energy space include: ICE DTCC Real-time reporting and time stamping of trades may be required. Recordkeeping requirements apply to all swap counterparties, including those with an end user exception. 6
Dodd-Frank Designations Swap Dealer (SD) An entity that: 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 the person to be commonly known in the trade as a dealer or market maker in swaps. Major Swap Participant (MSP) A person that maintains a substantial position in any of the major swap categories, excluding positions held for hedging or mitigating commercial risk and positions maintained by certain employee benefit plans for hedging or mitigating risks in the operation of the plan; A person whose outstanding swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. banking system or financial markets; Any financial entity that is highly leveraged relative to the amount of capital such entity holds and that is not subject to capital requirements established by an appropriate Federal banking agency and that maintains a substantial position in any of the major swap categories. 7
Dodd-Frank Designations But I m an End User!! End User is not a designation of an entity type under Dodd-Frank. The CFTC has not proposed a definition for End User and is not expected to propose a definition. Non-Swap Dealer, Non-Major Swap Participant Also referred to as an End User or Other. No Registration Required If you do not register as a Swap Dealer or a Major Swap Participant, you will be considered a Non-Swap Dealer, Non-Major Swap Participant. 8 EDF TRADING
The End User Exception The End User exception relieves a company of the obligation of mandatory clearing of swaps. Exception cannot be elected for the entire organization. Exception is requested on a transaction basis and requires Board approval. There are a number of reporting requirements associated with an end user exception. A swap may be exempt from mandatory clearing if one of the counterparties to the swap: Is not a financial entity; Is using swaps to hedge or mitigate commercial risk; and Notifies the CFTC how it generally meets its financial obligations associated with entering uncleared swaps. Companies may still be required to post initial and variation margin on transactions. If the company with an end user exception elects to clear, it may select the Derivatives Clearing Organization (DCO) where the swap will be cleared. 9
Swap Dealer Requirements Just to name a few Registration with CFTC by way of the NFA. Completion of Form 7-R. Principals may need to complete Form 8-R, including fingerprints and background checks. Associated persons (APs) probably will not need to register. APs include traders, originators and those affecting swaps. Verification of no statutory disqualification. Anticipated costs: Application fee $15,000, initial membership dues, annual dues. NFA is seeking additional guidance from CFTC on registration process. Business conduct with counterparties (CP). Know your counterparty (KYC) requirements. Suitability requirement for recommendations to CPs. Disclosure of material risks and scenario analysis to CPs. Reckless disregard standard for trades where CP is committing fraud. Price must bear a reasonable resemblance to the best terms available. Must provide a daily mark for marker mid-point to CP for uncleared swaps. 10 Internal business conduct standards. Capital and margin requirements for non-banks.
De Minimis Exemption As Proposed Entities that fulfill all of these requirements are not expected to be classified as a SD: Gross notional value of swaps entered into during the prior twelve months cannot exceed $100 million. (This value is expected to be MUCH higher in final rule.) Aggregate effective notional value of swaps traded with special entities (federal/state agencies and political subdivisions including cities, counties and municipalities) over the prior 12 months cannot exceed $25 million. Firm must not have entered into swaps as a dealer with more than 15 counterparties over the prior 12 months. (May not be included in final version.) Firm must not have entered into more than 20 swaps as a dealer during the prior 12 months. (May not be included in final version.) 11
Federal Position Limits Compliance of federal position limits is mandatory for all market participants regardless of entity designation. 28 Core Referenced Contracts were specified. Four of these are energy contracts: NYMEX Henry Hub Natural Gas (NG) NYMEX Light Sweet Crude Oil (CL) NYMEX New York Harbor Gasoline Blendstock (RB) NYMEX New York Harbor Heating Oil (HO). Federal position limits include futures, swaps and options. Anticipated compliance dates a guesstimate at best! Spot month position limits sometime in Summer 2012? Non-spot month position limits sometime mid-2013? 12
Federal Position Limits Reporting Positions must be aggregated for entities that share a 10% or greater ownership or equity interest. Positions must be monitored intra-day but are reported end-of-day. Breach of federal position limits must be reported with any hedge exemptions within three days or at least ten business before breach for anticipatory hedges. What is a hedge exemption? Must fit the definition of a bona fide hedge. Must fit into one of eight hedging buckets. If the transaction does not fit into one of the buckets it will more than likely be considered a speculative transaction. 13
Dodd-Frank Impacts Impacts at the Team Level All teams will be impacted regardless of entity designation. A majority of the issues impact multiple teams. Here are a few of the impacts on each team. Team Trading Origination Credit Back Office Risk Management Compliance/Legal IT Potential Daily Impacts/Process Changes KYC including CP verification and classification; pre-trade execution; trade input process; trade type determination; time-stamping of trades. Automate as much of the process as possible. KYC including CP verification and classification; end user exception; clearing exception; contract review. Less automation needed because timing is less of an issue. Initial and variation margining; collateral management; clearing exempt trades; changes in netting requirements; CP review; position limits; new contracts including CPs, SEFs, DCOs. Portfolio reconciliation, trade reporting requirements, Changes in netting requirements, same day confirmation; CP review; new contracts with SEFs, DCOs. Position limits; portfolio reconciliation; documentation; CP review. Documentation, including compliance manual; recordkeeping requirements; training requirements; CP review ; contract review; operations control documentation; contracts with SEFs, DCOs. Instrumental in assisting with almost every process, especially those involving trade and data entry, reporting, real-time and new interfaces to SEFs, SDRs and DCOs. Significant system enhancements/additions regardless of entity designation. If SD, there will be a number of compliance related requirements. 14
What s Next? The CFTC Schedule Twenty-seven CFTC rules have been finalized. Proposed rules are still being issued. The CFTC has not issued a complete published schedule or timeline for rule finalization. They did release a tentative rulemaking schedule on September 8, 2011 but the CFTC was unable to adhere to these guidelines. Entity definitions: Swap Dealer and Major Swap Participant Product definitions: swap CFTC scheduled meetings: March 9, 2012 (may move to March 7, 2012) March 23, 2012 15
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