Dodd-Frank and Emir Rattle Derivatives Users

Terry Flanagan

Financial institutions are gauging the impact of increased capital requirements on certain business lines, with the introduction of central clearing expected to result in lower margins, increased collateral requirements and a general increase in the cost of doing business in areas such as OTC derivatives.

The majority of derivatives end-users facing compliance requirements from Dodd-Frank and Emir are underprepared to meet key obligations for one or both sets of rules, according to a recent survey from Chatham Financial.

Among a sampling of more than 150 companies, 60 percent of respondents who face regulatory requirements from Dodd-Frank indicated that they are not yet prepared for compliance, with nearly three-quarters (74 percent) of end-users facing EMIR compliance stating that they were not fully prepared.

“Right now, as many firms are working toward complying with their home country regulations, they’re just beginning to scratch the surface of additional regulations stemming from the jurisdictions of their counterparties,” said Luke Zubrod, director at Chatham Financial. “This means additional cost, confusion and uncertainty – the very factors end users enter into derivatives to avoid.”

The U.S. Commodity Futures Trading Commission has proposed safeguards with respect to a futures commission merchant (FCM) withdrawing futures customers’ funds from segregated accounts that are part of the FCM’s residual interest in such accounts.

The CFTC plans to require an FCM to maintain a residual interest in customer segregated accounts in an amount sufficient to cover all customer accounts that are under-margined, thereby ensuring that residual interest in customer segregated accounts exceeds the sum of outstanding margin deficits for customers, and that the funds of one customer are not used to margin or guarantee the positions of another customer.

The CFTC is concerned that such withdrawals may result in the FCM failing to hold sufficient funds to meet its obligations to its futures customers, or in the funds of one futures customer margining or securing the positions of another futures customer.

The derivatives industry is fighting the proposal, arguing that the CFTC’s analysis is flawed.

“The Residual Interest proposal is inconsistent with the current and established FCM business model, and would refashion the FCM’s role from one of guarantor and post-customer-failure resource to a prefunded resource,” said Robert Pickel, chairman of the International Swaps and Derivatives Association, in a May 8 comment letter.

Regulators are currently discussing a system of recognition whereby counterparties in different jurisdictions can comply with one set of rules but satisfy both regimes’ obligations, so long as the rules are designed to produce equivalent outcomes. Until such a system is put in place, Dodd-Frank will apply for any transaction in which a U.S. entity is a party and Emir will apply whenever an E.U. entity is a party.

According to the Chatham survey, end-users are underprepared for both regimes. Forty-four percent of respondents indicated that they were unsure of their firm’s status under Emir, signaling a need for further understanding of the provision’s applicability to derivatives end-users who operate or transact with counterparties located in Europe. Ten percent stated that they did not yet know if Dodd-Frank compliance requirements apply to their firm.

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