Regulatory Developments: ISDA and FIA publish template cleared derivatives documentation
ISDA and FIA have recently published two template agreements that address the clearing of bilaterally negotiated, over-the-counter derivatives transactions.
On August 29, 2012, ISDA and FIA published the FIA-ISDA Cleared Derivatives Addendum. The addendum is a template for use by market participants that have entered into swaps which will be cleared where the clearing member is a registered futures commission merchant and is intended to supplement the customer agreement between the clearing member and its client as regards cleared swaps. The Addendum addresses issues such as (i) portability of positions, (ii) procedures for the clearing member to close out and liquidate cleared swaps upon the occurrence of certain close-out events or tax events, including the calculation of the termination amount (iii) the use of credit support to reduce any termination amounts payable, (iv) tax provisions, (v) representations by the parties and (vi) required disclosures.
On September 20, 2012, ISDA and FIA published version 1.1 of the ISDA-FIA Cleared Derivatives Execution Agreement (which replaces version 1). The agreement is a template for market participants to use in negotiating execution-related agreements with counterparties to swaps that are intended to be cleared.
ISDA and FIA initially published their template execution agreement in June 2011. On August 1, 2011, the CFTC published a notice of proposed rulemaking ("NOPR") which strongly criticized the template execution agreement. The CFTC's main objection to the execution agreement was the optional annexes which permitted the clearing member to one or both of the parties to become a party to the execution agreement and therefore learn the identity of the customer's executing brokers (which is contrary to current market practice). The CFTC voiced concern that the annexes were inconsistent with the Dodd-Frank Act's principles of ensuring that customers have open access to clearing and exchange trading. The CFTC stated in the NOPR that market participants had expressed concerns that when the customer's counterparty and clearing member are affiliated entities, disclosure of the customer's identity may lead the dealer counterparty and clearing member to exchange information that could effectively force the customer to execute with the clearing member's affiliate, limiting the customer's potential counterparties and reducing the customer's opportunity to obtain execution of a swap on terms that have a reasonable relationship to the best terms available.
To address these concerns, the NOPR proposes to prohibit a futures commission merchant (FCM) that clears customer trades and a swap dealer (SD) or major swap participant (MSP) that enters into a cleared swap from entering into any arrangement that:
(1) discloses to the FCM or any SD or MSP the identity of a customer's original executing counterparty (including the SD that is the customer's original counterparty)
(2) limits the number of counterparties with whom a customer may enter into a trade that is intended to be cleared
(3) restricts the size of the position a customer may take with any individual counterparty, apart from an overall limit for all positions held by the customer at the customer's clearing member
(4) reduces a customer's ability to execute a trade on terms that have a reasonable relationship to the best terms available
(5)prevents compliance with specified timeframes for acceptance of trades into clearing frames
The comment period for the NOPR ended on September 30, 2012.
Version 1.1 of the Execution Agreement differs from version 1 in two key respects:
(1) The optional annexes that allowed a clearing member to become a party to the agreement have been deleted. As a result, the credit limits that the clearing member was permitted to set by virtue of the annexes have also been deleted. Such limits would have disclosed to the clearing member the identity of the customer's counterparty.
(2) Insertion of language that sets forth time frames in which the parties must take action to accept or reject the trade. Additional language has been added to make clear that the parties will follow the time frames as mandated by CFTC regulations i.e. to address the requirement that trades must be accepted or rejected for clearing as soon as technologically possible.
ISDA and FIA have noted that the execution agreement working group will continue to consider any necessary market-place or regulatory changes to the execution agreement and therefore further versions may be published in due course.
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