The Swap Documentation Subcommittee

of the ABAs Futures and Derivatives Law Committee

Webinar:
New Cleared Swap Documentation
for U.S. Markets

Wednesday, August 15, 2012

12 noon (Eastern Time)

AGENDA
1.
1

Status and Timeline of U.S.

U S Clearing Mandate

Claire Hall, White & Case

2. 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
4 FIA Cleared
4.
Cl
dD
Derivatives
i ti
T
Transaction
ti
Add
Addendum
d
Maria Chiodi, Credit Suisse
5. FIA/ISDA Cleared Derivatives Execution Agreement
Jonathan Ching, Jones Day
6. Other Related Issues
Jonathan Ching & Warren Davis

( )( ) of the Dodd-Frank Wall Street Transparency

p
y and Accountabilityy Act
Section 723(a)(3)
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 clearing to a derivatives clearing organization that is registered 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

Dodd-Frank
Frank Act sets forth a corollary provision applicable to
security-based swaps.

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

cleared?

When will the clearing requirement take effect?

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

What advance preparation can a client do today?

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

cleared?
l
d?

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 list

of pproducts theyy pplan to accept
p for clearing.
g

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

Dodd-Frank Act were deemed submitted to the CFTC.
CFTC reviewed submissions and recently proposed regulations that would
require that certain classes of credit default swaps (CDS) and interest rate
swaps (IRS) be cleared by DCOs.
p
6,, 2012
Comment Deadline: September

When will clearing requirement take effect?

CFTC Proposed Part 39.5(e)

39 5(e) puts in place a compliance schedule that
will be triggered once the CFTC has issued a determination that a
product is required to be cleared.

How much lead time will clients have to pprepare

p for compliance?
p

Final determination on initial products to be required to be cleared is

expected in November 2012 (aka T)

Category 1 Entities will be required to comply with mandatory clearing

requirements by T + 90 days

Category 1 Entities included swap dealers, major swap participants and

active funds
Active fund any private fund as defined in Section 202(a) of the
Investment Advisors Act of 1940, that is not a third-party subaccount
h executes 200 or more swaps a monthh based
b d on a monthly
hl
andd that
average over the 12 months preceding the Commission issuing a
mandatory clearing determination.

How much lead time will clients have to pprepare

p for compliance?
p

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.

What advance preparation can a client do today?

o

Identify prospective clearing members for clearing swaps.

Set documentation priorities.

Initiate discussions about preferred documentation terms.

10

OTC Derivatives
D i i
Execution and Clearing
Lauren Teigland-Hunt
T i l d H t LLP New
Teigland-Hunt
N
Y
York
k

2011THLLP
11

Overview
Exchange Traded Contracts v. OTC Derivatives
Futures Execution and Clearing
Uncleared OTC Swap Execution
Uncleared OTC Swap Documentation
Cleared Swap Execution and Clearing
FIA-ISDA Execution Agreement
FIA Addendum
2011THLLP
12

Exchange-Traded vs OTC Derivatives

Standardized,, exchange-traded
g
contracts
Futures contracts
Listed options
Soon: Swaps traded on Swap
Swap Execution Facilities
Facilities

Over-the-counter (OTC) derivatives are privatelynegotiated contracts that may be customized and are not
traded on a centralized exchange
Forwards
OTC Swaps
S
OTC Options

2011THLLP
13

Futures Execution and Clearing:

Executing Broker Representation on Anonymous Markets
Futures Give-Up
Agreement;
no disclosure to
clearing member of
executing
counterparty

Bilateral
Cl i
Clearing
Agreement

Alpha
Fund

1
Sends order

DCO/
Clearinghouse
5

Resulting
5
cleared trade

Resulting cleared
trade

4
Matched trade
submitted for
clearing

XYZ FCM/
Clearing
Member

Other
FCM/Clearing
Member

Give up

ABC
Executing
Broker*

Anonymous
Market

2
Represents
sale / enters
order

3 Trade executed on
Anonymous Market

Floor
Trader/Local

Enters
order

* Futures Give-Up Arrangement: representation of Alpha by Executing Broker to Anonymous Market. ABC Executing Broker
is acting on behalf of Alpha Fund as Alphas agent
agent. ABC EB takes Alphas order to the Exchange and can execute the trade
with anyone in the market to secure best price. XYZ FCM does not know identity of trade counterparties.
2011THLLP
14

OTC Swap Execution (no clearing)

Bilateral ISDA Master Agreement
Bet een Alpha Fund
Between
F nd and DB
Governs

Alpha
Fund

Sell

TRADE EXECUTED
DIRECTLY
OFF-EXCHANGE

2011THLLP
15

Buy

DB

OTC Uncleared Swap Documentation

ISDA
Master Agreement
(with Schedule &
CSA)
Trade
Confirmation
(
(e.g.,
iinterest
t
t rate
t
swap)

Trade
Confirmation
(
(e.g.,
equity
it callll
option)

2011THLLP
16

Trade
Confirmation
(
(copper
forward
f
d
purchase/sale)

Cleared Swap Execution and Clearing

CME Contract 2

CME Contract 1

CS (as
Alphas
FCM/Clearer)
Sell

CME

CME

DBSI

Buy

Sell

Buy

IF
ACCEPTED

Bilateral
Clearing
Agreement

CME (as DCO)

Cleared Trade
Results

Sell

Alpha
Fund

Uncleared Trade
Results
IF
(subject to
REJECTED Execution Agreement
b/t Alpha and
DB)

Submitted
for Clearing
TRADE EXECUTED
DIRECTLY
OFF-EXCHANGE or on SEF

Bilateral Execution
Agreement
g
2011THLLP
17

Buy

DB

Warren N. Davis

Futures Customer Account Agreements

18

Were Not in ISDA-Land Anymore

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

FUTURES LAND

ISDA LAND

CLEARED
SWAPS LAND

19

2012 Sutherland Asbill & Brennan LLP

Were Not in ISDA-Land Anymore (Cont.)

Risks

Documentation

Cash Flows

Parties

ISDA Land
(principal to principal)

Futures Land
(agency relationship)

Counterparty Credit Risk

Operational Risk
Liquidity Risk
Early Termination Risk

Fellow-Customer
Fellow
Customer Risk
Operational Risk
Liquidity Risk
Early Termination Risk
Investment Risk

ISDA Master Agreement

Schedule
CSA
Paragraph 13
Periodic Swap Payments
Variation Margin
[Independent Amounts]

Customer Account Agreement

Give-Up Agreement
Purchase Price
Sales Proceeds
Initial Margin
Variation Margin
Executing Dealers
Futures Commission Merchants
D i ti
Derivatives
Clearing
Cl i
Organizations

Counterparties
[C t di
[Custodians]
]
20

2012 Sutherland Asbill & Brennan LLP

Were Not in ISDA-Land Anymore (Cont.)

Cleared Swaps Land
(agency relationship)

Counterparty
credit risk is
replaced by
liquidity and early
termination risks

Risks

Investment Risk
O
Operational
Risk
Liquidity Risk
Early Termination Risk

Documentation

Futures Customer Account Agreement

Cleared Derivatives Transactions Addendum
Cleared Derivatives Execution Agreement

Cash Flows

P ti
Parties

Upfront Payments
Initial Margin
Variation Margin
Sales Proceeds
Periodic Swap
p Payments
y
PAI (Price Alignment Interest)

New agreements
New payment
obligations

Counterparties
Executing Dealers
Additional p
parties
F t
Futures
Commission
C
i i M
Merchants
h t
Derivatives Clearing Organizations
[Custodians]
2012 Sutherland Asbill & Brennan LLP
21

Adoption of the Futures Model for Cleared

Swaps (Cont.)

22

2012 Sutherland Asbill & Brennan LLP

Futures Customer Account Agreements

Typically not negotiated
Tend to be extremely one
one-sided
sided in favor of the FCM
Not standardized
Although
g futures customer account agreements
g
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
th extent
the
t t they
th are nott addressed
dd
db
by th
the Add
Addendum
d
See Section 9 of the FIA Addendum, the Inconsistency
provision

23

2012 Sutherland Asbill & Brennan LLP

Futures Customer Account Agreements

Typically Address, Among Other Things

Margin Requirements
E
Events
t off Default
D f lt and
d Liquidation
Li id ti off P
Positions
iti
Payment Obligations
Position Limits
Security Interests
Termination Rights
g
The Transfer of Funds
Assignment

24

2012 Sutherland Asbill & Brennan LLP

Under the Typical Futures Customer

Account Agreement

The FCM may unilaterally set and increase margin

requirements over and above clearing house requirements at
any time

There are no cure periods for events of default

An FCM may declare an event of default to have occurred,
occurred or
avail itself of remedies as if an event of default has occurred, if it
deems it necessary for its protection
The FCM may unilaterally limit customer
customers
s positions at any time
Either party may terminate the agreement with notice
FCMs may use futures collateral to satisfy obligations under
other
th agreements
t with
ith th
the FCM or its
it affiliates
ffili t
The FCM may assign the agreement at any time

25

2012 Sutherland Asbill & Brennan LLP

Key Futures Customer Account Agreement

Provisions to Negotiate

Who the parties to the futures customer account agreement are

FCM financial information,
information representations and warranties
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
Indemnification
Partial porting (porting is generally addressed only in the
context of termination of the futures customer account
agreement)

26

2012 Sutherland Asbill & Brennan LLP

FIA Cleared Derivatives

Addendum
Maria Chiodi
Credit Suisse

27

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 clearing of swaps.

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
addenda.
addenda

Many parties are already negotiating cleared derivatives addenda

based on recent drafts of FIA Addendum.

28

Status/Scope of FIA Addendum

StatusofFIAAddendum

Afteraseriesofdeliberationsthattookplaceovermorethan18
f
f
p
months,anFIAWorkingGrouprecentlycompletedtheFIA
Addendum.

ScopeofFIAAddendum
Allswaps,forwards,optionsorsimilartransactions
( h th
(whetherexecutedintheOTCmarketortradedonaSEFor
t d i th OTC
k t t d d
SEF
aDCM)thataresubmittedtoandacceptedforclearingby
aclearingorganization.

29

Content of FIA Addendum

Definitions
Representations and Covenants of Clearing Member
and Customer
Applicable
pp
Law ((including
g DCO/SEF rules);
)
Authorizations
Transactions Not Accepted for Clearing
Li it ti off Liability
Limitation
Li bilit
Transfer of Positions (aka portability)
Events of Default/Liquidation
Tax Provisions

30

Section 7 of FIA Addendum

Liquidation

Clearing Member may designate a

Liquidation Date upon a Liquidation Event.

Clearing Member will enter into Close-out

Close out
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.

31

Section 7 of FIA Addendum

Liquidation (contd)

If Clearing Member, after commercially

reasonable efforts, determines that close-out
t d are nott readily
trades
dil available
il bl or would
ld nott
(or would require solicitation of quotes that
would not) satisfy Liquidation
Liquidation Standard
Standard , the
Clearing Member shall be entitled to value
such transactions in accordance with Section
7(b)(i)(B) of the Addendum.

32

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
commercially reasonable procedures in order to produce a commercially reasonable
result;
provided further, that Clearing Member may effect Closeout Transactions, Riskreducing Transactions and Mitigation Transactions with Clearing Member or Clearing
M b affiliates,
Members
ffili t
and
d an affiliate
ffili t off Clearing
Cl i M
Member
b may effect
ff t a Miti
Mitigation
ti
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 by
Cl i M
Clearing
Member;
b
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.

33

FIA/ISDA Cleared Derivatives Execution Agreement

g
Jonathan Ching
August 15, 2012

34

What is an Execution Agreement?

A bilateral agreement
g
between a customer and its counterparty
p y
that governs the submission of a swap for clearing and
establishes procedures for when a swap is not accepted for
clearing
A FIA/ISDA working
An
ki group consisting
i ti off b
buy-side
id and
d sell-side
ll id
swap market participants developed a form of Execution
Agreement last year (published in June 2012)
Originally
Originally, the form agreement could be modified to become a tritri
party or four-party agreement that included the parties clearing
members as parties to the agreement
The CFTC adopted final rules earlier this year that prohibit entry into
a tri
tri-party
party or four
four-party
party Execution Agreement
The FIA/ISDA working group is expected to publish a second
version of the form Execution Agreement that takes into account the
CFTCs rules

Generally, the form Execution Agreement is intended to be the

starting point for negotiations

35

Submitting a Swap for Clearing

Swap
p is executed bilaterally
y
The dealer counterparty must submit the swap for
clearing to the relevant clearing house:*
As soon as technologically practicable but no later
than the close of business on the day of execution if
the swap is subject to mandatory clearing
If the swap is not subject to mandatory clearing
clearing, no
later than the next business day after the execution
of 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
Customer must affirm the details of the swap*
swap

36

Submitting a Swap for Clearing (Cont.)

Clearing houses and clearing members must accept

or reject each trade submitted for clearing as quickly
as would be technologically practicable if fully
automated
t
t d systems
t
were used*
d*
Once a swap is accepted for clearing, the swap
between the dealer and customer is replaced
p
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.

37

Transactions Not Accepted for Clearing

Unless otherwise agreed

agreed, if a swap is not accepted
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 or
through
g an affiliate ((if it or its affiliate is a
clearing member)
If the swap is not subject to mandatory clearing,
th dealer
the
d l may acceptt th
the swap as an over-theth
counter, bilateral transaction
The dealer may terminate the swap, in which
case the dealer or customer will pay an Early
Termination Amount

38

Cleared Swap
p Documentation: Other Issues
Jonathan Ching (Jones Day) and Warren Davis (Sutherland)
August 15, 2012

39

Recap: Clearing Changes Trade Structure

Assume you execute 30-yr USD fixed to floating rate
sswap
ap with
t Dealer
ea e X,, tthen
e sub
submitt tthat
at ttrade
ade for
o cclearing:
ea g
Term is reduced to the length of notice required
before FCM can exercise termination rights
Haircut/initial margin levels standardized by CCP and
not individually negotiated
Both parties are required to post margin
Margin levels can vary during the life of the trade
Customer counterparty is CCP (not dealer bank)
Valuation is determined by CCP and no bespoke
di
dispute
t rights
i ht may b
be iinvoked
k d

40

Risk Allocation
FCM will impose credit terms on clients that allow
them to manage their risks,
risks including guarantee
fund obligations and other capital requirements.
Trading desks seek to mitigate the operational risk
during the period from trade execution to
acceptance for clearing.
Understanding that there are competing and not
necessarily consistent agendas within a single
institution will help clients to better analyze their
d
documentation
t ti needs.
d

41

Market Practice and Expectations

There is a wide discrepancy in expectations about the
market
a et for
o ccleared
ea ed O
OTC
C de
derivatives:
at es
How quickly will trades be accepted for clearing?
How much liquidity will exist for these trades once
they are cleared?
How well will the operational systems work and how
often will trades break?
In a world where clearing is required,
required is it permissible
for parties to resubmit trades that are rejected from
clearing?
Your documentation can vary depending on the answers
to these questions.

42

The Swap Documentation Subcommittee

of the ABAs Futures and Derivatives Law Committee

Webinar:
New Cleared Swap Documentation
for U.S. Markets

Questions & Answers

43