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 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 1. 1 Status and Timeline of U.S. U S Clearing Mandate

( )( ) of the Dodd-Frank Wall Street Transparency p y and Accountability y 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 p products they yp plan 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 p prepare 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 d that h executes 200 or more swaps a month h based b d on a monthly hl and average over the 12 months preceding the Commission issuing a mandatory clearing determination.

How much lead time will clients have to p prepare 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 o o

Identify prospective clearing members for clearing swaps. Set documentation priorities. Initiate discussions about preferred documentation terms.

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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

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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
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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

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Futures Execution and Clearing: Executing Broker Representation on Anonymous Markets

Futures Give-Up Agreement; no disclosure to clearing member of executing counterparty

DCO/ Clearinghouse
Resulting 5 cleared trade 4 Matched trade submitted for clearing 5 Resulting cleared trade

Bilateral Cl i Clearing Agreement

XYZ FCM/ Clearing Member

Give up

Other FCM/Clearing Member Floor Trader/Local

Alpha Fund

1 Sends order

ABC Executing Broker*

2 Represents sale / enters order

Anonymous Market
3 Trade executed on Anonymous Market

2 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

Buy

DB

2011THLLP 15

OTC Uncleared Swap Documentation

ISDA Master Agreement (with Schedule & CSA) Trade Confirmation ( (e.g., i interest t t rate t swap) Trade Confirmation ( (e.g., equity it call ll option) Trade Confirmation ( (copper forward f d purchase/sale)

2011THLLP 16

Cleared Swap Execution and Clearing

CME Contract 1 CME Contract 2

CS (as Alphas FCM/Clearer) Sell

CME
Buy

CME
Sell

DBSI
Buy

IF ACCEPTED

Bilateral Clearing Agreement

CME (as DCO) Cleared Trade Results

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 Buy

Sell

Alpha Fund

DB

Bilateral Execution Agreement g

2011THLLP 17

Warren N. Davis

Futures Customer Account Agreements

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Were Not in ISDA-Land Anymore

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

ISDA LAND

FUTURES LAND

CLEARED SWAPS LAND

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2012 Sutherland Asbill & Brennan LLP

Were Not in ISDA-Land Anymore (Cont.)

ISDA Land (principal to principal) Counterparty Credit Risk Operational Risk Liquidity Risk Early Termination Risk ISDA Master Agreement Schedule CSA Paragraph 13 Periodic Swap Payments Variation Margin [Independent Amounts] Futures Land (agency relationship) Fellow-Customer Fellow Customer Risk Operational Risk Liquidity Risk Early Termination Risk Investment Risk 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
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2012 Sutherland Asbill & Brennan LLP

Risks

Documentation

Cash Flows

Parties

Counterparties [C t di [Custodians] ]

Were Not in ISDA-Land Anymore (Cont.)

Cleared Swaps Land (agency relationship) Risks Investment Risk O Operational Risk Liquidity Risk Early Termination Risk

Counterparty credit risk is replaced by liquidity and early termination risks

Documentation

Futures Customer Account Agreement Cleared Derivatives Transactions Addendum Cleared Derivatives Execution Agreement Upfront Payments Initial Margin Variation Margin Sales Proceeds Periodic Swap p Payments y PAI (Price Alignment Interest)

New agreements New payment obligations

Cash Flows

P ti Parties

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
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Adoption of the Futures Model for Cleared Swaps (Cont.)

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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 not t addressed dd db by th the Add Addendum d
See Section 9 of the FIA Addendum, the Inconsistency provision

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2012 Sutherland Asbill & Brennan LLP

Futures Customer Account Agreements Typically Address, Among Other Things Margin Requirements E Events t of f Default D f lt and d Liquidation Li id ti of fP Positions iti Payment Obligations Position Limits Security Interests Termination Rights g The Transfer of Funds Assignment

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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

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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)
2012 Sutherland Asbill & Brennan LLP

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FIA Cleared Derivatives Addendum

Maria Chiodi Credit Suisse

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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.

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Status/Scope of FIA Addendum

StatusofFIAAddendum

After f aseriesof fdeliberationsthattookplace p overmorethan18 months,anFIAWorkingGrouprecentlycompletedtheFIA Addendum.

ScopeofFIAAddendum Allswaps,forwards,optionsorsimilartransactions ( h th executed (whether t din i the th OTCmarket k tort traded d donaSEFor aDCM)thataresubmittedtoandacceptedforclearingby aclearingorganization.

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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 of Limitation f Liability Li bilit Transfer of Positions (aka portability) Events of Default/Liquidation Tax Provisions

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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.

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Section 7 of FIA Addendum Liquidation (contd)

If Clearing Member, after commercially reasonable efforts, determines that close-out t d are not trades t readily dil available il bl or would ld not t (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.

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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 of f 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.

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FIA/ISDA Cleared Derivatives Execution Agreement g

Jonathan Ching August 15, 2012

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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 of fb 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

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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

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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.

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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 accept t 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

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Cleared Swap p Documentation: Other Issues

Jonathan Ching (Jones Day) and Warren Davis (Sutherland) August 15, 2012

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Recap: Clearing Changes Trade Structure

Assume you execute 30-yr USD fixed to floating rate swap s ap with t Dealer ea e X, ,t then e sub submit tt that at t trade ade for o c clearing: 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 i invoked k d

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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

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Market Practice and Expectations

There is a wide discrepancy in expectations about the market a et for o c cleared 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.

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The Swap Documentation Subcommittee of the ABAs Futures and Derivatives Law Committee

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

Questions & Answers

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