Reporting and Collateral Top OTC Agenda

Terry Flanagan

Mandatory clearing and reporting of OTC transactions is having a profound impact on the way that market participants interact with each other from a legal and collateral perspective.

The International Swaps and Derivatives Association has launched the Isda 2013 Reporting Protocol, which contains a counterparty’s consent to the disclosure of information, and is intended to facilitate market participants’ compliance with mandatory trade reporting requirements.

Isda is also publishing side letters (principal and agent versions), which parties can enter into bilaterally, that contain the same consent language as found in the Protocol.

To the extent that parties may need to satisfy additional disclosure requirements, it may be possible to incorporate such additional requirements into the Side Letters on a bilateral basis.

“We are committed to making markets safer and more efficient, and the Isda 2013 Reporting Protocol and side letters are among the many tools that ISDA is making available to help market participants meet their trade reporting obligations,” said Robert Pickel, Isda Chief Executive Officer.

Global regulations and changing market dynamics are also mandating new and complex requirements for the use of collateral, which are forcing both sell-side and buy-side firms to reevaluate their need for and use of collateral.

Mandatory clearing of OTC derivatives transactions has dealers and swap participants scrambling to marshal their assets to meet collateral obligations, a process known as “collateral transformation.

Collateral transformation is a form of collateral optimization – which is making sure that collateral is allocated as efficiently as possible, and the process will include swapping bad collateral for good collateral. If properly optimized, the lowest acceptable grade collateral is pledged, working from worse to best.

“The drains on collateral have brought to light pockets of untapped liquidity,” said Bradley Foster, managing director at Deutsche Bank, at last week’s Financial Markets Reform conference sponsored by Markit. “Corporate America is sitting on massive piles of collateral, as are sovereign wealth funds. “The ability to transform capital is directly related to the degree to which these pools of liquidity can be accessed.”

Isda’s Dodd-Frank documentation initiative provides a standard set of amendments, in the form of protocols, to facilitate updating of existing swap relationship documentation for Dodd-Frank compliance.

Isda has published separate Protocols facilitating compliance with certain requirements. The first such protocol, formally titled Isda August 2012 DF Protocol, allows swap market participants to simultaneously amend multiple Isda master agreements. Isda will soon publish a Protocol doing the same for Emir requirements.

These Protocols also include, or will include, disclosure consents. The Reporting Protocol is intended to be more generic than the Dodd-Frank and Emir Protocols, while being consistent with them.

The Reporting Protocol may be particularly useful for market participants who, due to the nature or level of their trading activity, may not be required to comply with certain provisions of the Dodd-Frank and Emir Protocols but who nonetheless face trade reporting obligations.

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