The 2009 Dodd-Frank Act created the Commodity Futures Trading Commission (CFTC) and established a framework for the regulation of financial derivatives. The CFTC has created several rules related to the recordkeeping and reporting of financial derivatives. So … are you ready for Dodd-Frank? Here are ten key questions and answers to help you evaluate the impact on your organization.
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1. Do I have to comply with the requirements of Dodd-Frank?
If you participate in contracts intended to be financially settled without physical delivery (Swaps as defined by Dodd-Frank), you are impacted by the Dodd-Frank Act.
2. What changes or new requirements does Dodd-Frank create?
New rules related to participant registration and transaction recordkeeping and reporting are created.
3. What should I do now?
First, evaluate your current and historical contracts to determine if they are intended to be settled without physical delivery thus requiring you to comply with Dodd-Frank. Second, based on the historical volume of transactions, determine if you could potentially be a swap dealer or major swap participant. If you fall into the category of end user, evaluate if the counterparties you work with will be swap dealers or major swap participants and thus fulfill the reporting requirements for you. Finally, assess the systems you currently have in place to maintain records on your financial transactions and establish a strategy to ensure compliance with the new reporting requirements.
4. What records are required to be maintained and by whom?
All parities participating in financial instrument transactions are required to maintain full and complete records. While we anticipate these records to include the counterparty, key terms, contract documents or confirmations, etc., the specific requirements will be outlined in CFTC Rule Publication 17 CFR Part 23 which is pending at this time. These records must be maintained for five years after the transaction is terminated or fulfilled. While electronic records are preferred, end users are allowed to maintain paper records; however they still must be able to be produced within five days of a request.
5. Are these record keeping requirements new?
Although the formal regulatory requirement to maintain these specific records is new, the business need to maintain this information is not. Much of this information is likely already maintained for purposes of tracking transactions, evaluating hedge effectiveness and completing year end reporting under generally accepted accounting principles within annual financial statements. The format of the data as well as the length of time that the records need to be easily accessible is likely new.
6. Am I required to register with the CFTC?
This depends on the annual swap volume of your entity.
Any entity that executes more than $8 billion in commodity swaps or credit default swaps, $400 million for other security based swaps or $25 million for swaps with “special entities" in a year must register with the CFTC as a “swap dealer."
A “major swap participant" (MSP) is an entity which does not meet the requirements of a swap dealer, however based on the volume of transactions, the ongoing counterparty exposure and periodic evaluation under a complex calculation are required to register with the CFTC. We note that the CFTC and SEC do not anticipate many entities to register as MSPs.
“End users" are entities that enter into financial contracts (commonly known as derivatives) to hedge their own commercial risk, such as a utility, which is hedging fuel costs or power needs. To be an end user you cannot be a swap dealers or major swap participant. End users are not required to register.
“Special entities" include municipalities, endowments, employee benefit plans or other related entities such as governmental utilities. Special entities would only be required to register if they meet the definition of a swap dealer or a major swap participant.
7. Who is required to complete the CFTC reporting?
In most cases the burden for reporting falls to the swap dealer or the major swap participant. If, however, the transaction is between two end users then the agreement will need to designate which party is required to report the data to the CFTC. All swaps will require reporting as soon as possible. For swaps executed electronically this may be as quickly as 30 minutes after execution.
8. Are there exceptions?
Of course! The new rules don’t apply to contracts that are intended to settle with physical delivery. These contracts can still be exceptions even if they include netting arrangements and book-out provisions. In addition, on August 21 the CFTC proposed an additional rule that would exclude certain transactions for financial transmission rights (FTRs), future energy and future capacity, which are made through established regional transmission organizations (RTOs) and independent system operators (ISOs) which petitioned the CFTC for the change and whose rates are regulated by a federal or state agency.
9. When are the rules effective?
While the CFTC has finalized several rules to date, there are still more rules pending. Each rule issued contains an effective date 60 after issuance. This is complicated by the interrelationship between the rules. While some of these rules are already effective, implementation may be contingent upon a rule not yet issued.
10. Are these rules finalized?
No. The CFTC continues to evaluate additional petitions for changes to the issued rules. For example, several industry organizations have requested that the CFTC review the level of transactions with special entities which require registration as a swap dealer and raise the level from $25 million to ensure there is a fully functional market available to special entities. In addition, there are varying political views on the desired level of regulation of financial derivatives so the upcoming election could impact the ultimate implementation of the current or pending rules.
How Baker Tilly can help
Now that you have determined how Dodd-Frank impacts your business, it is important to understand how a professional firm can assist you in meeting the requirements. Baker Tilly offers experience in the following areas pertaining to Dodd-Frank:
- Initial Dodd-Frank assessment of contracts or transactions
- Define and identify optimum requirements
- Document Gaps and Establish a Road Map for Adherence
- Implementation Assistance