Derivatives Industry Crafts Transition Plan

Terry Flanagan

Implementation would be phased in, with mandatory clearing to begin in 2013.

The derivatives industry has created a master plan for the transition to a centrally traded and cleared swaps world, and is urging regulators to tailor its rulemaking to fit the plan.

The plan, developed by the Futures Industry Association, the International Swaps and Derivatives Association, and Sifma, envisions a three-stage transition process.

Phase one would include establishing and implementing swap data repositories (SDRs). Phase two would implement registration, clearing and capital and margin rubles to reduce systemic and operational risk. Phase three would implement swap execution facilities (SEFs) and designated contract market (DCM) execution requirements.

Within each of the three stages, compliance would be phased in by type of market participant. Compliance would first be required of the largest and most sophisticated participants, including swap dealers and major swap participants. Next, compliance would be required of private funds, and lastly by nonfinancial end users.

The three-stage phase-in approach should be implemented in lockstep with regulators, self-regulatory organizations such as the National Futures Association, and market infrastructure providers.

“Such synchronization is essential to ensure that market participants whose swap activities are subject to multiple regulators and SROs can coordinate their own internal work streams to avoid duplication of work or conflicting compliance dates,” the associations said in a letter to the CFTC.

The master plan sequences the rulemaking required under Dodd-Frank that’s appropriate for each phase.

For example, before margin and capital requirements become mandatory (phase two), the CFTC would need to adopt final rules on margin for uncleared swaps and protection of collateral of counterparties to uncleared swaps, among other rules.

The plan envisions the first mandatory clearing requirements for buy side participants coming into effect in the second quarter of 2013. In addition, the CFTC’s final decision of protection of cleared customer collateral, including ether the CFTC chooses a full segregation of legally segregated/operationally commingled (LSOC) model, may impact the time needed to prepare for clearing.

Once mandatory clearing has been implemented, capital and margin for uncleared swaps can be phased in. “Rules relating to uncleared swap margin should not apply to a market participant for swaps that are required to be cleared until that market participant is required to clear the particular swaps, the associations said.

Documentation will be a huge undertaking in and of itself. Large swaps dealers and FCMs will need to negotiate sign or amend a total of about 100,000 documents each with over 10,000 counterparties over a course of one to two years.

These documents include ISDA master agreement, credit support annexes, custody agreements, client representation letters, execution agreements, and clearing agreements.

ISDA and the FIA this year published the FIA-ISDA Cleared Derivatives Execution Agreement to serve as a “template” for participants in the cleared swaps market in negotiating execution-related agreements with counterparties to OTC derivatives.

The agreement includes optional annexes for those parties that want a clearing firm to be a party to the agreement as part of a trilateral agreement.

ISDA has also launched a standard credit support annex (SCSA), an agreement to an OTC derivatives contract that governs the calculation of collateral.

The SCSA seeks to standardize market practices by removing “embedded optionality” in the existing CSA, and also seeks to promote the adoption of overnight index swap discounting for derivatives.

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