Implications for energy companies, utilities and other over-the-counter market participants
It was July 21, 2010 when President
Barack Obama signed into law the
Dodd-Frank Wall Street Reform and
Consumer Protection Act. Fueled by the backlash of the 2008 financial crisis, this legislation represents the most sweeping overhaul of U.S. financial regulation since the 1930s.
Even though the Act centers on the financial services and capital markets industries, it includes provisions affecting all public and private companies. For companies engaged in commodities hedging or trading the most significant aspects of the Act are the rules regulating the overthe-counter (OTC) market. Commonly referred to as “derivative reform,” these rules are far-reaching and complex. As written, derivative reform
addresses all types of swaps: equity, interest rate, foreign exchange, credit default and commodity. For energy companies trading OTC commodity swaps there are four major areas to evaluate for business impact: clearing, data and reporting, position limits and new business conduct rules. Since no current OTC market participant will be left untouched, it is still imperative to understand the full scope of these regulations (see caption below).
While the specific rules of derivative reform have not yet been fully promulgated, and much is uncertain about the details of complying with
Dodd-Frank, enough is known to assess the impact this legislation will have on companies which enter into
OTC contracts today in the energy sector. Non-financial industries which participate in the OTC derivative markets include:
• Energy Companies
- Independent Oil & Gas
- Refining & Marketing
• Electric and
Natural Gas Utilities
• Mining and Mineral
• Consumer Products
What is a swap dealer and a major swap participant?
The Dodd-Frank Act defines a swap dealer as any person who: • Tends to accommodate demand for swaps from other parties;
A major swap participant satisfies any one of the following criteria:
• Holds itself out as a dealer in swaps;
• Is generally available to enter into swaps to facilitate other parties’ interest in entering into swaps;
• Maintains a “substantial position”; • Makes a market in swaps;
• Regularly enters into swaps with counterparties in the ordinary course of business for its own account, or engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps.
With these characteristics:
• Tends to enter into swaps on their own standard terms or on terms they arrange in response to other parties’ interest; and
• Tends to arrange customized terms for swaps upon request, or to create new types of swaps at their own initiative.
• Holds outstanding swaps which create “substantial counterparty exposure”; or
• Is a highly leveraged financial entity that maintains a “substantial position". End-users enter into swaps to hedge or mitigate commercial risk.
Many moving parts
Figure 1. Timeline for Derivative Reform Implementation
The original timeline for Derivative Reform is aggressive. Market participants are arguing for a phased approach to allow for an orderly, efficient and inclusive transition to the new market.
CFTC and SEC issue final regulation on Derivative Reform
EFFECTIVE DATE - TBD
Bill becomes effective
Registration of SDs and MSPs
Interim system until “technologically feasible”
Real-Time Reporting of all Swaps
Clearing/Exchange Trading - Post-Enactment Swaps
OTC derivatives cleared on exchanges
Clearing/Exchange Trading - Pre-Enactment Swaps
Proprietary Trading Study - Volcker Rule
Swaps Push Out Rule