U.S. DERIVATIVES REFORM (DODD-FRANK ACT, TITLE VII)

Transcription

1 FREQUENTLY ASKED QUESTIONS U.S. DERIVATIVES REFORM (DODD-FRANK ACT, TITLE VII) INTERNAL USE ONLY Comprehensive information for Relationship Managers and other staff of Julius Baer Group September 2015

2 Q1. What is the Dodd-Frank Act about? In 2009 the Group of 20 ( G20 ) countries met in Pittsburgh in order to discuss measures to avoid or at least mitigate financial crises like the one that started in 2007 in the future. The collapse of Lehman Brothers in 2008 showed the systemic risk of over-the-counter ( OTC ) derivatives and they were considered as one factor that led to the financial crisis. Up to this point the tremendous OTC derivative market was mostly unregulated. It was decided that the adoption of derivative reforms in all G20 countries should be one of the measures taken to avoid or mitigate financial crises in the future. The U.S. has played a leading role in the implementation of the measures defined by the G20 countries and transformed them into national law by introducing the Dodd-Frank Wall Street Reform and Consumer Protections Act ( Dodd-Frank Act ) in It is important to note that the Dodd-Frank Act does not only comprise the U.S. derivative reform, but far more topics like too big to fail, mortgages practices by banks and others. When discussing the U.S. derivative reform it should always be referred to Title VII of the Dodd-Frank Act. Title VII imposes new obligations for U.S. persons, counterparties of U.S. Persons and partially also for non-u.s. participants of the U.S. market when entering into OTC derivative transactions. A key goal of these new obligations is to bring greater transparency to the OTC swap market. Q2. What are the obligations under Dodd-Frank Act Title VII? Title VII of the Dodd-Frank Act imposes a full range of obligations on counterparties of OTC derivative transactions. The following picture should provide an overview of the obligations that mainly affect the clients of Julius Baer Group s banking entities ( JB ) and JB itself: A. ECP REQUIREMENT The Eligible Contract Participant ( ECP ) Requirement is actually not part of the Dodd-Frank Act itself, but of the U.S. Commodities Exchange Act ( CEA ) and had to be adhered to already before the Dodd-Frank Act came into effect. It prohibits persons, other than ECPs, from entering into swaps unless entered into on or subject to the rules of a designated contract market. As a consequence JB must not enter into OTC derivative transactions with clients who do not qualify as ECPs. than $10 million in assets, or any entity guaranteed by such entity. Individuals with aggregate amounts of more than $10 million invested on a discretionary basis (or $5 million if hedging). Entities with a net worth of at least $1 million that are hedging commercial risk. Financial institutions. Insurance companies. Investment companies. Commodity pools with more than $5 million in assets under management. Employee benefit plans under certain conditions B. REPORTING The Dodd-Frank Act knows three different types of reporting obligations: Swap Data Repository ( SDR ) Reporting: Details on the contract must be reported at close of business of the day after the conclusion / modification / closure the latest. The data must be reported to an SDR, which captures the data and provides it to the regulator. Historical SDR Reporting: Whereas the Dodd- Frank Act itself came into effect in July 2010, the SDR Reporting obligation started in April 2013 only. Historical SDR Reporting is the requirement to report positions which were opened between these dates. Real-time Reporting: Details on the contract must be reported within 15 minutes after its conclusion / modification / closure. Only one counterparty of the contract has the obligation to report. Which one is defined by a hierarchy in the law and depends on the proximity of the counterparty to the U.S. market (e.g if a U.S. Person deals with a Non-U.S. Person, the U.S. Person must report the transaction) and the level of sophistication of the counterparty (e.g. if a registered U.S. Swap Dealer deals with a private U.S. Person, the U.S. Swap Dealer must report the transaction). C. CLEARING One of the measures defined by the G20 countries to reduce the systemic risk is to clear transactions via a central counterparty ( CCP ). The contract between Party A and Party B is cancelled and replaced by two contracts one between Party A and the CCP and one between Party B and the CCP. The regulator defines which products should be mandatory for clearing in accordance with predefined characteristics (details see Q4 below). ECPs include: Corporations, partnerships, proprietorships, organizations, trusts, or other entities with more 2

3 D. SEF TRADING As soon as a product is mandatory for clearing, it can be made available to trade. As a consequence the contract must not be entered between two parties bilaterally anymore but has to be traded via a Swap Execution Facility ( SEF ). SEFs are exchanges in the U.S. that were established for OTC derivative trading only. Strictly speaking, the OTC derivative is not OTC anymore if traded via a SEF, but an exchange-traded derivative. Q3. Which clients are affected by Dodd- Frank Act Title VII? The U.S. split the responsibility for the implementation and enforcement of the Dodd-Frank Act between two authorities: the Commodities Futures Trading Commission ( CFTC ) and the Securities Exchange Commission ( SEC ), depending on the type of OTC derivative (details see Q4). The implementation of the Dodd-Frank Act is more advanced on the CFTC side than on the SEC side and unfortunately the definitions differ quite substantially. Furthermore, CFTC s definition is a new one, where no case law has been developed yet. As a consequence details of the definition are still unclear. This leads to cases where relationships are subject to exemptions granted by common SEC law and therefore approved by Legal Front, but are potentially still in scope of the obligations imposed by the Dodd-Frank Act. ACCORDING TO THE CFTC DEFINITION A U.S. PERSON GENERALLY INCLUDES, BUT IS NOT LIMITED TO (i) any natural person who is a resident of the United States; (ii) any estate of a decedent who was a resident of the United States at the time of death; (iii) any corporation, partnership, limited liability company, business or other trust, association, jointstock company, fund or any form of enterprise similar to any of the forgoing other than an entity described in prongs (iv) or (v) below (a legal entity ), in each case that is organized or incorporated under the laws of a state or other jurisdiction in the United States or having its principal place of business in the United States; (iv) any pension plan for the employees, officers or principals of a legal entity described in prong (iii), unless the pension plan is primarily for foreign employees of such entity; (v) any trust governed by the laws of a state or other jurisdiction in the United States, if a court within the United States is able to exercise primary supervision over the administration of the trust; (vi) any commodity pool, pooled account, investment fund or other collective investment vehicle that is not described in prong (iii) and that is majority-owned by one or more persons described in prong (i), (ii), (iii), (iv), or (v), except any commodity pool, pooled account, investment fund, or other collective investment vehicle that is publicly offered only to non-u.s. persons and not offered to U.S. persons; (vii) any legal entity (other than a limited liability company, limited liability partnership or similar entity where all of the owners or of the entity have limited liability) that is directly or indirectly majority-owned by one or more persons described in prong (i), (ii), (iii), (iv), or (v) and in which such person(s) bears unlimited responsibility for the obligations and liabilities of the legal entity; and (viii) any individual account or joint account (discretionary or not) where the beneficial owner (or one of the beneficial owners in the case of a joint 3

4 account) is a person described in prong (i), (ii), (iii), (iv), (v), (vi), or (vii). Q4. Which products are affected by the additional requirements? In general title VII of the Dodd-Frank Act applies to every product that is defined as a swap (CFTC s responsibility) or a security-based swap (SEC s responsibility). Adapting these terms to JB terminology they could be roughly translated into OTC derivative as defined in policy D-1219 Trading in OTC Derivatives, with the exemption of FX Forwards and FX Swaps: Asset classes Foreign exchange ( FX ) Derivatives Products included Non deliverable forwards All types of FX options from plain vanilla to exotic Accumulators / Decumulators / Target Redemption Forwards ( TARFs ) Contracts for Difference ( CFDs ) Rates Rate restriction transactions (caps, floors, collars) Forward rate agreements ( FRAs ) Interest rate options from plain vanilla to exotic Interest rate swaps Interest rate swaptions CFDs Equities All types of options from plain vanilla to exotic Commodities (including precious metals ( PM )) Swap contracts (e.g. total return (equity) swaps) Options on exchange-traded funds ( ETFs ), traditional funds and nontraditional funds ( NTFs ) CFDs PM forward transactions All types of PM options from plain vanilla to exotic PM swaps CFDs Other forward commodity transactions, options on commodities and also on the corresponding indices Credit Credit Default Swaps ( CDS ) CFDs FX Forwards and FX Swaps are not defined as swaps and are therefore excluded from all obligations, except from the SDR Reporting and Historic SDR Reporting (see Q2). Subject to the clearing and SEF trading obligations are currently only interest rate swaps and credit default swaps. It is expected that non-deliverable forwards and FX options will be the next products to become subject to these obligations but no date has been confirmed yet for this extension. Q5. What is JB s approach to deal with clients who are potentially affected by Dodd- Frank Act Title VII? JB S STATUS UNDER THE DODD-FRANK ACT JB is not registered as a Swap Dealer or Major Swap Participant. The registration of a Swap Dealer would be required if JB s trading volume in OTC derivatives exceeded 8 billion USD. This threshold will be reduced to 3 billion at some point (not yet defined). Registered Swap Dealers face the highest degree of Dodd-Frank obligations, both on entity level as well as on transaction level. Among Swiss banks UBS AG is the only one which is registered as a Swap Dealer under the Dodd-Frank Act. JB is no U.S. Person under the definition of the Dodd-Frank Act, neither is it an Affiliate Conduit or U.S. Person Guaranteed. JB is an Eligible Contract Participant (see Q2 (A)). Bank Julius Baer & Co. Ltd. ( BJB ) has signed the ISDA August 2012 Dodd-Frank Protocol as well as the ISDA March 2013 Dodd-Frank Protocol. Both Protocols add notices, representations and covenants responsive to Dodd Frank Title VII requirements and can be found on the ISDA website. IMPLEMENTATION OF THE DODD-FRANK ACT OBLIGATIONS WITHIN JB JB has decided not to implement any requirements set under the Dodd-Frank Act. As a consequence, certain products which are in scope of the obligations cannot be offered to clients that are defined as U.S. Persons according to CFTC (see Q3): Interest rate swaps and credit default swaps are subject to both the clearing obligation as well as the SEF obligation. JB is no clearing member of a U.S. approved CCP and no member of a SEF. It is essential that no such products are traded with U.S. Persons as JB and the client would be in breach of the Dodd-Frank Act the moment the transaction is executed. JB also does not offer its U.S. clients to delegate their reporting obligation to the bank. As explained in Q2 (B) FX forwards and FX swaps are not subject to any Dodd-Frank obligations with the exception 4

5 of SDR and Historic SDR Reporting. U.S. clients who trade OTC derivatives, including FX forwards and FX swaps, and do not report them to an SDR within one day after the execution / modification / closure of the contract, are in breach of the Dodd-Frank Act. A. CLIENTS SERVICED BY AN OFFSHORE REG- ISTERED INVESTMENT ADVISOR ( ORIA ) According to policy D Requirements under the US Securities Law section 5, accounts in the name of U.S. clients which are serviced by an ORIA must be set up at the E-Desk in Zurich. For this reason the following paragraphs apply to BJB Switzerland only. In 2013 BJB informed all ORIAs about the Dodd- Frank Act Title VII and the additional obligations that arise due to this law. It was pointed out that it is in the responsibility of the ORIA to ensure proper reporting in accordance with the applicable U.S. laws, rules and regulations. Furthermore, the ORIA was made aware of the fact that BJB cannot sell interest rate swaps and credit default swaps to the ORIA s clients anymore. The letter also contained a reminder that it is the ORIA s obligation to adhere to the ECP Requirement. cases, or must be closed. PM Business may decide whether a mandate is suitable to be transformed into a bespoke mandate or not. D. ADVISORY / SELF-DIRECTED CLIENTS Advisory and self-directed clients that may be subject to the Dodd-Frank Act Title VII were informed about their potential obligations and the product restrictions set by JB in February It is the client s responsibility to adhere to the Dodd-Frank rules when trading OTC derivatives. The clients were informed that they are required to stop entering into OTC derivative transactions if they are not in a position to comply with the Dodd- Frank Act. The ORIAs will receive another information letter as soon as further asset classes become mandatory for clearing. B. CLIENTS WHO ARE SERVICED BY AN EAM THAT IS NO ORIA ( 15/25 EXEMPTION ) EAMs which are no ORIAs were informed in 2013 as well in a similar way as the ORIAs. The EAMs had to confirm compliance with the Dodd-Frank Act. They will receive another information letter as soon as further asset classes become mandatory for clearing. C. CLIENTS WHO HAVE A DISCRETIONARY AGREEMENT WITH BJB Due to the fact that clients who have a discretionary agreement with BJB are often not aware of the transactions executed on their behalf or monitor the transactions only at a later stage, such clients are not able to comply with the SDR Reporting obligation. Considering this circumstance JB decided that discretionary agreements with clients who fall under CFTC s definition of a U.S. Person must either contain a restriction on OTC derivatives, which means a change to a bespoke mandate in most 5

6 Important legal information No representation, warranty, or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information contained in this document. Neither Bank Julius Baer & Co. Ltd. nor any other entity of the Julius Baer Group accepts any obligation to any recipient to update or correct any information contained herein. The information and opinions expressed in these FAQ s were produced by Bank Julius Baer & Co. Ltd., Zurich, as of the date of writing and are subject to change without notice. The information in these FAQ s is published for information purposes only and does not constitute an analysis of all potentially material issues. These FAQ s have been prepared without taking account of the objectives, financial situation or needs of any particular client. Julius Baer recommends that any client independently assesses, with a professional advisor, the specific legal, regulatory and other consequences. NEITHER THESE FAQ s NOR ANY COPY THEREOF MAY BE SENT, TAKEN INTO OR DISTRIBUTED IN THE UNITED STATES OR TO ANY US PERSON.