Impact on Asian Institutions

SINGAP-1-131612-v1 BUS-DEV

The Dodd-Frank Act and the Proposed EU Regulation on OTC Derivatives Impact on Asian Institutions

The Dodd-Frank Act and the Proposed EU Regulation on OTC Derivatives - Impact on Asian Institutions December 2010

© Clifford Chance Pte Ltd 2010

Introduction 1

Overview of the Dodd-Frank Act 3

Overview of the Proposed EU Regulation 11

Implications for Asian institutions 14

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This memorandum has been prepared for ISDA by Clifford Chance Singapore in consultation with colleagues from Clifford Chance London, New York and Hong Kong. The information contained within this document is correct as at 21 December 2010. This publication does not necessarily deal with every important topic nor cover every aspect of the topics with which it deals. It is not designed to provide legal or other advice. If you would like to know more about the subjects covered in this publication or our services, please contact: Lena Ng +65 6410 2215 Paget Dare Bryan +852 2826 2459 Chris Bates +44 20 7006 1041 David Felsenthal +1 212 878 3452 To email one of the above, please use [email protected] © Clifford Chance Pte. Ltd December 2010 One George Street, 19th Floor, Singapore 049145 www.cliffordchance.com


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Introduction This memorandum provides an overview of the impact of the US Dodd-Frank Act and the proposed EU Regulation on over-

the-counter (“OTC”) derivatives, with a particular focus on how these changes will impact on institutions in Asia participating in

the OTC derivatives markets.

At the Pittsburgh summit in September 2009, the leaders of the G20 made a strong commitment to regulatory reform of the

market for OTC derivatives. In particular, they declared that:

“All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where

appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be

reported to trade repositories.”

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was passed into US law on 21 July

2010. Running to over 800 pages, and with 16 titles or chapters it has been hailed as the most sweeping financial services

regulatory reform legislation in US since 1933, covering a broad sweep of issues - ranging from systemic supervision, changes

to the regulation of investment advisors and the regulation of OTC derivatives to measures aimed at improving consumer

protection.

The proposal for an EU Regulation on OTC derivatives, central counterparties and trade repositories (the “Proposed EU

Regulation”) was published on 15 Sept 2010 – the second anniversary of the Lehman collapse. It covers the regulation of

three important aspects of the OTC market: regulation of OTC derivatives themselves, regulation of the central counterparties

(“CCPs”) which would be expected to clear the bulk of OTC contracts and regulation of trade repositories, which are perceived

by regulators on either side of the Atlantic as integral to the implementation of one of the core objectives of the G20 - to bring

more transparency to OTC derivatives markets.

There are some broad similarities between the Dodd-Frank Act reforms and those under the Proposed EU Regulation but

there are also some notable differences in approach. In particular, the Dodd-Frank Act addresses a number of issues relating

to the regulation of OTC derivatives not addressed at all in the Proposed EU Regulation, such as the registration (i.e.

licensing) of OTC derivatives dealers and the requirements for trading of OTC derivatives through organised trading platforms.

In the EU, the former issue was already dealt with under the 2004 Markets in Financial Instruments Directive (“MiFID”), which

is itself under separate review. The European Commission has only recently published its consultation paper on the MiFID

review which includes some proposals to change the boundary of the EU authorisation requirements for firms dealing in OTC

derivatives and detailed proposals relating to the trading of OTC derivatives through organised trading platforms (as well other

measures, such as position limits and position management powers for OTC derivatives).

This memorandum does not address the proposals discussed in the MiFID review or other current EU initiatives, such as the

proposals for reform of the Market Abuse Directive provisions dealing with insider dealing and market manipulation which

apply to derivatives.

Other wider issues addressed in the Dodd-Frank Act, such as the "Volcker Rule" restrictions on proprietary trading by banking

groups and the "Push-Out Rule" restricting the extent to which banking entities can trade in OTC derivatives, currently have no

counterpart in the EU regulatory agenda, although there are political currents that might lead to similar proposals surfacing at a

later stage.

There are also differences even in the areas where the Dodd-Frank Act overlaps with the Proposed EU Regulation. Most

importantly, there are significant differences in timing. The provisions of the Dodd-Frank Act relating to the regulation of OTC

derivatives markets are scheduled to come into effect, for the most part, in mid-2011 (although there is a longer schedule for

implementation of the Volcker and Push-out Rules). In contrast, the Proposed EU Regulation has to complete its passage

through the legislative process and is only likely to be fully implemented by the end of 2012. In addition, there are more

detailed differences. For example, while both sets of reforms have exemptions from the clearing obligation for transactions with

end-users, the relevant end-user exemption is effectively more narrowly defined under the Dodd-Frank Act than under the

Proposed EU Regulation.

2 The Dodd-Frank Act and the Proposed EU Regulation on OTC Derivatives - Impact on Asian Institutions December 2010


The question on the lips of many of the players in Asian OTC derivatives markets is this: Why are the US and EU reforms

relevant to me? There are three principal ways in which these reforms will affect market participants in Asia:

■ Asian market participants may trade in OTC derivatives with US or EU based banks or other counterparties and, as a

result, may in some cases, become directly subject to the requirements in the US or EU legislation (where it has direct

extraterritorial effect) or be affected by the legislation because of the requirements imposed on their counterparties. The

US legislation also includes provisions that allow the US regulators to adopt rules that directly apply to market

participants trading in OTC derivatives outside the US, even with non-US counterparties.

■ Asian market participants may be affected by the new rules as a result of the presence that they or their fellow group

companies have in the US or the EU. If Asian market participants, such as Asian banks, operate through branches in the

US or EU, then they will be directly subject to the new requirements. In addition, if they are members of a group of

companies with subsidiaries or other affiliates in the US or the EU, their fellow group companies will be directly subject to

the reforms, which may have spillover effects on them through intra-group trading and the application of group policies.

Even more significantly, some of the requirements of the US legislation, such as the Volcker Rule, apply extraterritorially

to all the members of a banking group with a banking subsidiary, branch or agency in the US, although there are some

exemptions that are particularly relevant for non-US headquartered groups.

■ It is likely that at least some aspects of the US and EU reforms will serve as a guide to other countries, including Asian

jurisdictions, which are considering implementing the G20 commitments.

However, while the general direction can be seen, there is much in the proposed reforms which is as yet unclear. The

Proposed EU Regulation is just a legislative proposal and will evolve and be amended significantly during the legislative

process. In addition, both the Dodd-Frank Act and the Proposed EU Regulation require the adoption of implementing rules

which will significantly affect the way in which the new rules apply. This rule-making is still work in progress, even in the US.

Therefore, this memorandum merely reflects an assessment of the likely implications for Asia institutions at this point in time

and highlights those areas which any market participant should monitor over the weeks and months ahead as the shape of the

regulatory landscape begins to emerge.

This memorandum covers the following1:

■ Overview of the Dodd-Frank Act

■ Overview of the Proposed EU Regulation

■ Implications for Asian institutions

1 For a more detailed analysis of the differences between the US and EU reforms, please refer to Regulation of OTC

derivatives markets - A comparison of EU and US initiatives jointly published by ISDA and Clifford Chance and available on

the Clifford Chance website at:

http://www.cliffordchance.com/publicationviews/publications/2010/09/regulation_of_otcderivativesmarkets-.html


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Overview of the Dodd-Frank Act Introduction The regulation of OTC derivatives is only one facet of the Dodd-Frank Act. The Dodd-Frank Act makes a wide range of

changes to the financial regulatory framework, including major changes to the rules on capital and systemic risk regulation,

regulation of investment advisers/fund management, liquidation/resolution arrangements, credit rating agency reform and

investor and consumer protection. This memorandum does not cover these and focuses only on those provisions directly

relevant to the OTC derivatives markets.

While the Dodd-Frank Act has an immensely broad sweep, it does not address a number of issues where reform might have

been expected and might be considered necessary by many market commentators. One such example is that it does little to

streamline the regulatory infrastructure in the US. Instead of significantly reducing the number of regulators with overlapping

jurisdiction, the Dodd-Frank Act creates a new Financial Stability Oversight Council to oversee the existing regulators.

Regulatory overlap will continue to be a major issue for banks and other institutions.

In addition, the Dodd-Frank Act provides little detail of important tests and definitions. Much of the Dodd-Frank Act is devoted

to setting guidelines, basic parameters and standards. The difficult task of defining terms and establishing how these

regulations are going to work in practice has been left to the rule-making process which is currently underway by the relevant

regulators – notably in the context of OTC derivatives, the Commodities Futures Trading Commission (the “CFTC”) and the

Securities and Exchange Commission (“SEC”). Until the final rules are available, there will continue to be considerable

uncertainty about how the legislation will apply in practice.

So having said what Dodd-Frank does not address, let us look at what it does provide for in the context of OTC derivatives.

Below is an overview of the following topics in the Dodd-Frank Act affecting OTC derivatives:

■ Registration of swap dealers and major swap participants

■ Push-Out Rule

■ Swap clearing and execution

■ Swap reporting

■ Margin

■ Volcker Rule

The OTC derivatives reform provisions are in Title VII (Wall Street Transparency and Accountability) of the Dodd-Frank Act,

while the Volcker Rule is in Title VI (Improvements to Regulation of Bank and Savings Association Holding Companies and

Depository Institutions) of the Dodd-Frank Act.

Registration of swap dealers and major swap participants Before looking at the new registration regime, the following provides a quick overview of: who will be the regulators of OTC

derivatives, what will be considered “swaps” and what will be considered “security-based swaps”?

Who will be the regulators? As mentioned above, there has been no general streamlining of regulatory agencies under the Dodd-Frank Act and this is

particularly true for the regulation of OTC derivatives.

Under the new regime, OTC derivatives will be regulated by both the CFTC and the SEC. Whether you are regulated by the

CFTC and/or the SEC is not dependent on the type of institution but instead depends on the relevant activity – whether you

are engaged in “swaps” (in which case you are regulated by the CFTC) or “security-based swaps” (in which case you are

regulated by the SEC). If you engage in both “swaps” and “security-based swaps” – which will be the case for many of the

major market makers - you will need to be registered and hence regulated by both the SEC and the CFTC.

What is a “swap”? “Swaps” are defined as options, contingent forwards, exchanges of payment or transactions that are based on an underlying

financial product, or a contract that becomes known as a swap in the market. Interest rate swaps, currency swaps, foreign



exchange swaps, total return swaps and credit default swaps are explicitly defined as “swaps”. The definition of swaps

specifically excludes:

■ contracts for sale of commodities for future delivery,

■ the sale of a non-financial commodity for deferred delivery, so long as the transaction is intended to be physically settled,

■ any put or call that is subject to the securities laws,

■ any foreign exchange put, call or option that is traded on a national exchange,

■ non-contingent sales of securities subject to the securities laws,

■ contingent sales of securities not dependent on the creditworthiness of a party other than a party to the agreement,

■ agreements based on a security and entered into with an underwriter for the purpose of capital raising (but not for the purpose of risk management),

■ agreements with the Federal Reserve or the Federal Government and any agency thereof,

■ security-based swaps, and

■ certain foreign exchange contracts as described below.

Foreign exchange options would be swaps. Foreign exchange forwards and swaps would also be regulated as swaps,

although the Treasury Secretary may make a written determination to exempt foreign exchange forwards and swaps from

regulation under the Dodd-Frank Act. This has not happened so far, but there have been some developments in this area. On

28 October 2010, the US Treasury Department issued a consultation paper on the determination of the exemptions for foreign

exchange swaps and forwards and the conclusions are expected before July 2011 (but no specific timetable has been

offered). Even if exempted, foreign exchange forwards and swaps would still need to be reported and remain subject to the

business conduct standards applicable to swap dealers under the Dodd-Frank Act. It is not clear if cash-settled foreign

exchange swaps and forwards could be exempted by the Treasury Secretary.

What is a security-based swap? Security-based swaps, which will be regulated by the SEC, are defined as swaps which are based on a narrow-based security

index, a single security or loan and the occurrence or non-occurrence of an event relating to a single issuer of a security (or

the issuers of a narrow-based security index). A narrow-based security index is generally defined as an index with nine or

fewer components.

Unless the context requires otherwise, this memorandum will refer to either swaps or security-based swaps as “swaps”.

“Mixed swaps”, which have elements of both swaps and security-based swaps2, will be defined jointly by the SEC and the

CFTC, and will be regulated by the SEC as security-based swaps. Rules for novel swap products will be determined jointly by

the SEC and the CFTC

Who is required to register? Swap dealers and major swap participants will have to register.

Swap dealers and security-based swap dealers will have to register with the CFTC and the SEC, respectively, and if an entity

deals with both swap and security-based swaps or with mixed swaps, then it will have to register with both the CFTC and the

SEC. The CFTC has issued proposed rules setting out the process for registration, which will require dealers or major swap

participants to become members of the National Futures Association, and to file certain applications and demonstrate

compliance with the requirements of regulations issued under the Dodd-Frank Act.

A swap dealer is any person that holds itself out as a dealer in swaps, that makes a market in swaps, regularly enters into

swaps with counterparties in the ordinary course of business or its own account or engages in any activity causing it to be

commonly known in the trade as a swap dealer or market maker, provided that an insured depository institution will not be a

2 For example, a swap where one party takes the equity linked return while the other takes an interest rate return.


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considered a swap dealer if it enters into a swap with a customer in connection with originating a loan with such customer. A

person may be designated as a swap dealer for a single class, type, or category of swaps and not considered to be a swap

dealer for other types, classes or categories.

A swap dealer does not include an entity that buys or sells swaps for their own account, but not as a part of a regular business.

The CFTC and SEC jointly issued a proposed regulation in December 2010 to define “swap dealer”. The proposed regulation

uses the statutory definition, as described above, and the accompanying release adds that swap dealers are persons whose

function is to accommodate demand for swaps from other parties and enter into swaps in response to interest expressed by

other parties. The proposed regulation also provides that swaps will only be “entered into in connection with a loan” if the

swap is directly related to a financial term of such loan.

A “major swap participant” is a person that is not a swap dealer but (a) that maintains a substantial position in swaps for any

major swap category (other than for hedging or mitigating its own commercial risks and excluding positions maintained by

pension plans), (b) whose outstanding positions create substantial counterparty exposure that could have serious adverse

effects on the financial stability of US financial markets or (c) that is a financial entity that is highly leveraged and maintains a

substantial position in any major swap category. The CFTC or the SEC, as applicable, is required to define the term

“substantial position” at a prudent threshold for the effective monitoring, management and oversight of entities that are

systemically important or can significantly impact the US financial system.

The definition of major swap participant excludes any entity whose primary business is providing financing, and which uses

derivatives for the purpose of hedging underlying commercial risks related to interest rate and foreign currency exposures, 90

percent or more of which arise from financing that facilitates the purchase or lease of products, and 90 percent or more of

which are manufactured by the parent company or another subsidiary of the parent company. (In this memorandum “major

swap participant’ refers to both “major swap participants and “major security-based swap participants”.)

The CFTC and SEC jointly issued proposed rules on “major swap participants” in December 2010. The proposed rule defines

“substantial position” and “substantial counterparty exposure” with numerical tests based on uncollateralised exposures and

notional amounts. The rule and accompanying release do not address cross-border issues in defining major swap

participants, although the proposal does request comment as to whether sovereign wealth funds or other entities linked to

foreign governments should be excluded from the definition.

Swap dealers and major swap participants that register with the CFTC and/or SEC will also be subject to regulations to be

issued under the Dodd-Frank Act, which will include prudential, capital and margin requirements and also conduct of business

rules.

Notably, the Dodd-Frank Act does not contain explicit exemptions for non-US swap dealers or non-US major swap

participants. However, provisions of the Dodd-Frank Act relating to swaps will not apply to activities outside the US unless

such activities contravene rules adopted by the regulators or, for swaps but not security-based swaps, have a direct effect on

the US. Also, if the CFTC or the SEC determine that regulation of swaps in a foreign country undermines the stability of the

US financial system, the CFTC or the SEC may, in consultation with the Treasury, bar entities domiciled in such country from

any swap activities in the US. The CFTC has requested comment on the extraterritorial application of the swap dealer and

swap registration requirement. The request for comment states "a person outside the US who engages in swap dealing

activities and regularly enters into swaps with US persons would likely be required to register as a swap dealer."

The practical effect of such requirement is that it is likely that non-US swap dealers dealing with US customers will be required

to register with the CTFC and/or SEC or use a US swap dealer as an intermediary in any swap transactions.

It is not currently clear how the definition of major swap participant will apply to non-US entities. The question is whether major

end-users of swaps outside the US will be required to register with the SEC or CFTC because they trade in swaps with US

banks or other dealers. The proposed regulation has no reference to extra-territorial limits. The numerical tests in the

proposed regulation do not state explicitly which swaps will be included in the relevant calculation. The proposal asks for

comment as to whether sovereign wealth funds or entities linked to foreign governments should be excluded from the definition

of major swap participant.



Push-Out Rule The Dodd-Frank Act provides that no Federal assistance may be provided to any swap dealer or major swap participant (other

than any major swap participant that is an insured depository institution). This is commonly referred to as the “Push-Out Rule”.

This prohibition would not apply to a FDIC-insured depository institution that limited its swap activities to (a) hedging and other

risk management activities related to its own activities, and (b) acting as a swap dealer in transactions involving rates or

reference assets that a national bank may invest in. However, depository institutions are prohibited from acting as a swap

dealer for credit default swaps unless such swaps are cleared by a clearing organisation. This provision would permit banks to

act as dealers with respect to interest rate swaps, currency swaps, swaps on precious metals and cleared credit default swaps

on investment-grade reference entities.

Federal assistance is defined to include advances from the Federal Reserve and use of FDIC funds for the purposes of

purchasing debt, assets or equity, guaranteeing any debt or entering into any other arrangements. The prohibition of Federal

assistance will be effective two years from the effective date of the Dodd-Frank Act (which is 16 July 2011), so the prohibition

will be effective 16 July 2013. In addition, the Dodd-Frank Act provides that a depository institution may receive a period

(determined by the appropriate banking regulator and the SEC or the CFTC, as applicable) of not more than 24 months to

divest or spin-off its swap entity while remaining eligible for Federal assistance.

The practical effect of this rule is that US banks are likely to need to hive off some of their swaps business into non-bank

affiliates if they want to have continued access to Federal assistance. Because US banks may have to cease certain swap

dealing, their counterparties may need to deal with affiliates of the bank rather than the bank itself. Also, the push-out rule

could potentially affect whether a non-US branch (or the head office of a non-US bank) could become a US swap dealer The

issue would be whether a US branch of the bank could lose its access to federal assistance because the non-US branch of the

same bank (or the head office) had become a US swap dealer.

Swap clearing and execution The Dodd-Frank Act requires swaps designated by the regulators to be cleared through a derivatives clearing organisation

regulated by the CFTC (with respect to swaps) or through a securities clearing agency regulated by the SEC (with respect to

security-based swaps) or through a derivatives clearing organisation that is exempt from registration. Any person that is party

to such a swap is required to submit such swap to the relevant clearing organisation. This mandatory clearing requirement will

come into force 360 days after the enactment of the Dodd-Frank Act or within 60 days of the adoption of the relevant

implementing rules (if later).

There are certain exemptions from the mandatory clearing requirement.

First, a swap is not required to be cleared if no clearing organisation is willing to clear such swap.

Secondly, there is an “end-user exemption” providing that any counterparty that is (a) not a financial entity, (b) using swaps to

hedge or mitigate commercial risk, and (c) notifies the CFTC or the SEC, as applicable, how it generally meets its financial

obligations associated with entering into non-cleared swaps would not be subject to the mandatory clearing requirement.

The definition of financial entity in the Dodd-Frank Act is drafted3 t

o include, amongst others, a major swap participant. In this

connection, the Dodd-Frank Act provides that major swap participants must register with respect to a certain type, class or

category of swap. However, the exemption from clearing is denied to any person that is a major swap participant. Therefore, it

appears that an entity that is a major swap participant with respect to only one category of swaps may not be able to use the

exemption from clearing for other types of swaps in respect of which it is not a major swap participant. For example, an oil

3 A financial entity is:

• a swap dealer or major swap participant,

• a person predominantly engaged in banking or financial activities,

• a commodity pool or a private fund that make use of the 3(c)(1) or the 3(c)(7) exemption from registration under the 1940 Act,

• anyone required to be registered with the CFTC or the SEC (other than a public company), and an employee benefit plan.


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company that may be considered a major swap participant with respect to oil derivatives may not be able to avail itself of the

exemption from clearing for interest rate swaps.

In December 2010, the CFTC issued a proposed rule addressing the end-user exemption. The proposal provides that swaps

are used for “hedging or mitigating commercial risk” if they would qualify as hedging under accounting rules or if the swap is

economically appropriate to the reduction of risks in the management of a commercial enterprise. In addition, the proposed

rule states that notice of how an end-user meets its financial obligations related to non-cleared swaps (which is required under

the statute) may be delivered to a swap data repository.

The Dodd-Frank Act does not require swaps entered into prior to the application of the mandatory clearing requirement or prior

to the passage of the Dodd-Frank Act to be submitted for clearing. However, any swap that is not required to be cleared will

nevertheless be subject to reporting requirements (see below), and must be reported to a swap data repository.

Further, even if an entity is able to fall within the end-user exemption and is exempt from having to have its swaps cleared, the

end-user exemption does not go further to exempt such entity from margin requirements. In this connection, the Dodd-Frank

Act requires swap dealers to impose margin requirements on all swaps, even those which are not cleared. As such, end-users

are still required to meet margin requirements, although there has been talk in the US Congress that end-users should not be

subject to the margin requirements.

All swaps that are required to be cleared are also required to be executed on a regulated exchange or a swap execution facility

(“SEF”) unless no exchange or SEF is willing to list the swap. A SEF is defined as a trading system or platform that is not an

exchange but that allows multiple participants to execute or trade swaps (but not other types of contracts) by accepting bids

and offers made by other participants and that is open to multiple participants.

Entities exempt from the clearing requirement are also exempt from this execution requirement.

Swap reporting The Dodd-Frank Act requires each party that enters into a swap to report such swap to a swap data repository or a security-

based swap data repository (in this memorandum swap data repository will refer to either), or if there is no swap data

repository that would accept such a swap, to the CFTC or the SEC, as applicable. The CFTC and SEC have adopted rules

requiring reporting of swaps that were in existence before July 2011 to swap data repositories when such swap data

repositories are licensed.

This reporting requirement is applicable to all swaps and is not limited to swap dealers or major swap participants. The

requirements are also not limited to new swaps entered into after the requirements come into effect. There are also

requirements on market participants to report existing swaps as well.

Any entity that enters into a non-cleared swap which is not accepted by a swap data repository shall be required to maintain

books and records with respect to such swap in a way that the SEC or the CFTC may require, which shall be open to

inspection by various regulators as well as the US Department of Justice.

The Dodd-Frank Act provides that where one party is a swap dealer or a major swap participant then it is the swap dealer or

the major swap participant and not the end-user who is required to report. However, if neither party is a swap dealer or a major

swap participant or where both parties are major swap participants, then the parties are to decide who is to report.

The Dodd-Frank Act is not clear whether, if there is a failure to report, both parties in such a case are jointly liable or whether a

party can rely on the parties’ mutual agreement for the other party to report so as to shield it from liability for the compliance

failure.

The detailed information (including the identity of the parties to a swap) held by a swap data repository will be available to US

regulators and authorities and, under certain conditions, non-US regulators and authorities.

There are also public reporting requirements. The CFTC and the SEC shall require real time public reporting by clearing

organisations. The CFTC and the SEC, as applicable, will also make available to the public the aggregate data on swap

trading volumes and positions of swaps that are not cleared by clearing organisations but are instead reported to swap



repositories or the regulators. The CFTC and the SEC will promulgate rules that ensure that such public reporting does not

identify the parties.

Margin As part of the regulation of swap dealers and major swap participants, the Dodd-Frank Act provides that margin requirements

for both initial and variation margin will be imposed with respect to each non-cleared swap entered into by a swap dealer or a

major swap participant. The margin requirement for depository institutions will be set by the appropriate federal agency in

consultation with the CFTC or the SEC, as applicable, and the margin requirement for non-depository institutions will be set by

the CFTC or the SEC, as applicable, and shall be at least as strict as the capital requirement for depository institutions. In

addition, the margin requirements established for non-cleared swaps shall be appropriate to offset the substantially higher risk

associated with non-cleared swaps.

With respect to major swap participants, it is at this time not entirely clear how capital requirements for swaps will be imposed

on major swap participants that are otherwise unregulated and that are not subject to capital requirements.

In imposing capital requirements, the CFTC shall take into account the risks associated with other types or classes of swaps

engaged in and the other activities conducted by such entity that are not otherwise subject to regulation. Therefore, the capital

requirements of a swap dealer or a major swap participant may be significantly greater than for the swaps which subject such

entity to regulation.

It is at this time unclear how margin will be imposed on swaps. The Dodd-Frank Act mentions initial and variation margin.

Customarily, variation margin relates to mark-to-market valuations of swaps and it is not clear how initial margin would be

determined.

In terms of holding of margin, if margin is provided under a non-cleared swap, the counterparty that is not a swap dealer or a

major swap participant may require that the segregation of initial (but not variation) margin with a third party custodian. The

regulators may permit the use of non-cash collateral if doing so is consistent with the financial integrity of the markets and the

stability of the US financial system.

In respect of margin for cleared swaps, only a CFTC registered futures commission merchant will be permitted to accept and

hold margin with respect to a cleared swap and only an SEC registered broker, dealer or security-based swap dealer will be

permitted to accept and hold margin with respect to a cleared security-based swap.

Position limits With respect to swaps, the Dodd-Frank Act requires the CFTC to impose aggregate position limits on contracts traded on

exchanges, SEFs, foreign boards of trade as well as swaps that are not traded on an exchange or SEF but which perform a

significant price discovery function, provided that bona fide hedges in physical commodities are excluded. In determining

whether or not a swap performs a “significant price discovery function”, the CFTC will consider price linkage, arbitrage,

material price reference and material liquidity. The Dodd-Frank Act also provides the CFTC with the ability to exempt,

conditionally or unconditionally, any market participant or any type or class of swap from position limit requirements.

With respect to security-based swaps, the Dodd-Frank Act requires the SEC to impose limits on the size of positions in any

security-based swap held by any person. The SEC may require a person to aggregate their position in (a) any security-based

swap and any security, loan or group of securities on which such security-based swap is based, or (b) any security-based

swap and any security (or securities) a term of which is the basis for a material term of such security-based swap. The SEC

may exempt, conditionally or unconditionally, any person, swap or transaction from position limit requirements. The SEC may

also require self regulating organisations to set aggregate position limits with respect to their members.

There is also a large trader reporting requirement in that any position in a swap that had a significant price discovery function

and which exceeds a size specified by the SEC or the CFTC, as applicable, may not be entered into unless reported to the

applicable commission.

The restrictions mentioned above may be difficult to implement as establishing the amount of the position limit or the size of a

large trade could be difficult, and it is not clear whether position limits are linked to the notional amount of a swap position or to

an underlying asset.


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Who is impacted by the OTC regulations in Dodd-Frank? When it comes to determining who is impacted by the OTC regulations in the Dodd-Frank Act, there are some institutions to

whom it clearly does apply and those to whom it is not yet certain. For example, it is clear that US institutions, US branches,

agencies and subsidiaries of non-US financial institutions, non-US clearing houses, SEFs and swap data repositories and

foreign boards of trade are all impacted by the Dodd-Frank Act to some degree. What is less clear at present is whether the

activities of US institutions outside the US and the activities of non-US institutions outside the US could also be impacted

although it is very likely that any institution that enters into swaps with US counterparties will be affected at least to some

degree.

Volcker Rule While the OTC reforms mentioned above affect players in the OTC markets, the Volcker Rule affects banking entities (i.e.

insured depository institutions, insured depository institution holding companies, bank holding companies, and their affiliates

(collectively “banking group entities”)) and what they can and cannot do, including in relation to OTC derivatives.

The Volcker Rule consists of two parts: the first part is the prohibition of “proprietary trading” and the second part is the prohibition of “sponsoring” or acquiring of any ownership interest in “private equity funds” or “hedge funds”. The basic premise behind the Volcker Rule is that such activities are or are perceived to be risky activities and that banking group entities should not be engaging in risky activities.

Proprietary trading “Proprietary trading” is currently defined as engaging as a principal for the trading account of the banking group entity in any

transaction to purchase or sell, or otherwise acquire or dispose of, any security, any derivative, any contract of sale of a

commodity for future delivery, any option on any such security, derivative, or contract, or any other security or financial

instrument that the appropriate Federal banking agencies, the SEC, and the CFTC may determine by rule.

Subject to any restrictions or limitations that the appropriate Federal banking agencies, the SEC and the CFTC may impose,

the general prohibition on proprietary trading activities shall not apply with respect to: (i) the trading of obligations of the United

States, obligations of any state or political subdivision of a state, and obligations of or instruments issued by Ginnie Mae,

Fannie Mae, or Freddie Mac; (ii) trading of securities and other instruments in connection with underwriting or marketmaking-

related activities; (iii) risk-mitigating hedging activities in connection with and related to individual or aggregated positions,

contracts, or other holdings; (iv) trading on behalf of customers; (v) certain trading activities by regulated insurance companies;

and (vi) trading activities conducted solely outside of the United States by companies that are not directly or indirectly

controlled by a company organised under US law.

Investing in, sponsoring, and managing private equity and hedge funds The terms “private equity fund” and “hedge fund” shall mean an entity exempt from registration as an investment company

pursuant to Sections 3(c)(1) (100 investor exemption) or 3(c)(7) (qualified purchaser exemption) of the Investment Company

Act of 1940, or a similar fund as jointly determined by the appropriate Federal banking regulators. The term to “sponsor” a fund

is defined in the Dodd-Frank Act as: (i) serving as a general partner, managing member, or trustee of the fund; (ii) selecting or

controlling (or having employees, officers, directors, or agents who constitute) a majority of the fund’s directors, trustees, or

management of the fund; or (iii) sharing the same name, or a variation thereof, with the fund for corporate, marketing,

promotional, or other purposes.

Subject to any restrictions or limitations that the appropriate Federal banking agencies, the SEC and the CFTC may impose,

the general prohibition on “sponsoring” or investing in “private equity funds” or “hedge funds” shall not apply to certain

specified activities. Included in this list is a “foreign bank exemption” which excludes an investment made solely outside the

United States provided that the company making the investment or conducting the activity is not directly or indirectly owned or

controlled by a company organised under US law and that no ownership interest in the target hedge fund or private equity fund

is offered or sold to US residents.

There is also a de minimis exemption in that a banking group entity would be able to make and retain an investment in a

hedge fund or private equity fund that the banking group entity organises and offers, provided that within a year after the

establishment of the fund (with the possibility of two one year extensions) the ownership interest of the banking entity in the

fund shall be reduced through redemption, sale, or dilution to less than 3 percent of the total ownership interest in the fund.

The aggregate investments by a banking entity in hedge funds or private equity funds would be limited to 3 percent of Tier I

capital of the banking entity.



There is an overriding caveat in respect of exemptions in that no transaction or activity that may fall within an exemption from

the provisions of the Volcker Rule shall be permitted if the transaction or activity: (i) would involve material conflict of interest

between the banking group entity and its clients or counterparties; (ii) would result in an unsafe or unsound exposure; (iii)

would pose a threat to the safety and soundness of the banking group entity; or (iv) would pose a threat to the financial stability

of the United States.

Timing The Volcker Rule does not, however, come into effect for some time. The Financial Stability Oversight Council is tasked to

complete a study no later than six months after enactment of the Dodd-Frank Act and to make recommendations on

implementing the provisions of the Volcker Rule. The appropriate Federal banking agencies, the SEC and the CFTC shall

consider the findings of the study and shall promulgate jointly implementing regulations no later than nine months after the

date of the completion of the study by the Council.

The Dodd-Frank Act explicitly provides that such rules shall impose additional capital requirements and quantitative limitations,

including diversification requirements, regarding any proprietary trading activities or hedge or private fund-related activities that

are exempted from the provisions of the Volcker Rule if deemed to be appropriate to protect the safety and soundness of

banking group entities engaged in such activities.

The Volcker Rule provisions shall become effective on the earlier of 12 months after the issuance of implementing regulations

or two years after the Dodd-Frank Act’s enactment. The Dodd-Frank Act provides for a transition period of two years (with the

possibility of up to three one-year extensions) after the effective date of the Volcker Rule provisions for banking group entities

to bring their operations into compliance with the relevant regulatory requirements. With respect to investments in “illiquid

funds” the Federal Reserve may grant one additional extension of the compliance period for up to 5 years. An “illiquid fund” is

generally defined as a hedge fund or a private equity fund that is contractually committed (as of 1 May 2010) to invest

principally in illiquid assets, such as portfolio companies, real estate, and venture capital investments.

Dodd-Frank Act – Rulemakings Like many other pieces of complex legislation to come out of the US Congress in recent years, the Dodd-Frank Act relies on

federal agency rulemaking to give content and meaning to Congress’ own general declarations and broad, often ambiguous,

statements of intent. Throughout the Dodd-Frank Act are sweeping delegations of authority to federal banking, securities and

commodities regulators. Congress instructs the agencies to define technical financial terms used in the legislation without

elaboration as to their meaning; and to study and report back to Congress on many controversial proposals. As such, the

rulemaking process – conducted under deadlines set forth in the Dodd-Frank Act as well as public notice-and-comment

requirements – will be critical to any assessment of the ultimate impact of the legislation on the regulated activities of financial

market participants. Since the enactment of the Dodd-Frank Act, there has been a flurry of activity within the CFTC and the

SEC.

The CFTC has identified 30 areas where rules will be necessary. At the time of writing, the CFTC has issued more than 20

proposed rules4 for public consultation relating to issues such as registration process and duties of swap dealers and major

swap participants, registration of foreign boards of trade, the process for review of swaps for mandatory clearing, position

reports for physical commodity swaps and requirements for clearing organisations and SEFs. In addition to holding external

meetings with interested parties5, the CFTC has also encouraged the public to provide input on the rulemaking process6.

The SEC has also issued proposed rules for public comment including recent proposed rules on topics such as security-based

swap reporting, outline obligations of security-based swap repositories and an anti-manipulation rule for security-based

swaps.7

4 See http://www.cftc.gov/LawRegulation/DoddFrankAct/Dodd-FrankProposedRules/index.htm

5 For details see http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/index.htm

6 See http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/index.htm

7 See http://www.sec.gov/spotlight/dodd-frank/accomplishments.shtml


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Overview of the Proposed EU Regulation Introduction On 15 September 2010, the EU Commission published its formal legislative proposal for a Regulation on OTC derivatives,

central counterparties and trade repositories. The proposals cover requirements in relation to OTC derivative transactions in

relation to central clearing and reporting and provide a framework for the regulations of central counterparties and trade

repositories.

The proposals are in the form of an EU Regulation rather than an EU Directive. Regulations are directly applicable across the

EU and do not require member states to pass further implementing legislation in their jurisdiction. This should improve

harmonisation across member states in the application of the proposals and will facilitate the giving of regulatory powers to the

newly created European Securities and Markets Authority (“ESMA”), which commences operations on 1 January 2011.

The Proposed EU Regulation is to be considered by the European Council of Ministers and the European Parliament and is

expected to be approved, with amendments, during 2011. Thereafter, implementing regulatory standards must be adopted and

ESMA will make recommendations for these, after periods of consultation, by 30 June 2012.

Scope The Proposed EU Regulation applies to OTC derivative financial instruments covered by MiFID. This definition will encompass

a broad range of swaps, options, futures and other derivatives contracts on securities, currencies, interest rates, financial

indices, credit, commodities and other underlyings specified under MiFID. Previous guidance from the European Commission

on MiFID suggests that this definition does not encompass physically settled spot and forward foreign exchange transactions.

In addition, the MiFID definition has limited application to physically settled OTC commodity derivatives transactions, although

this is under consideration as part of the MiFID review.

Clearing requirement The Proposed EU Regulation reflects the G20 commitment that all standardised OTC derivatives contracts should be cleared

through CCPs by the end of 2012.

In this connection, the Proposed EU Regulation imposes a duty on all financial counterparties to clear “eligible” OTC

derivatives through a CCP (either an EU CCP authorised under the Regulation or a non-EU CCP recognised by ESMA as

being subject to “equivalent” regulation).

The definition of “financial counterparty” is very broad capturing banks, investment firms, insurance companies, registered

UCITS funds, pension funds and alternative investment fund managers. It does not, however, include central banks, national

debt managers and multi-lateral development banks.

A counterparty which is not a financial counterparty may nevertheless be subject to a clearing obligation if it takes positions in

OTC derivatives that exceed a “clearing threshold” to be specified by the EU Commission.

In calculating this threshold, the Proposed EU Regulation requires the EU Commission to take into account the systemic

relevance of the sum of net positions and exposures by counterparty per class of contract. If a non-financial counterparty’s

positions exceed the clearing threshold then it will be subject to the clearing obligation for all its eligible derivative contracts.

In calculating the positions of a non-financial counterparty for this purpose, there will be disregarded any derivative contracts

entered into by the non-financial counterparty that are “objectively measurable as directly linked to the commercial activity of

the counterparty” (which should cover most hedging transactions).

How are contracts determined to be as “eligible” or not? It seems that both a “bottom up” and a “top down” approach will be

taken.

The “bottom up” approach envisages that a CCP that wishes to clear a class of OTC derivatives contracts would apply to its

home state regulator for authorisation to clear those contracts. If the home state regulator authorises the CCP to clear the

contracts, then it informs ESMA of its decision. ESMA then has six months to decide whether to treat these contracts as

eligible. ESMA is to make its decision based on criteria such as whether this would result in reduction of risk in the financial

system and the liquidity of contracts.



Under the “top down” approach, ESMA can itself identify and notify the EU Commission of classes of OTC contracts that it

considers should be treated as eligible, even where no CCP has made an application for authorisation to clear such contracts.

However, it cannot compel a CCP to begin clearing those contracts.

Risk management for non-cleared contracts For non-eligible and hence non-cleared contracts, financial counterparties and non-financial counterparties subject to a

clearing obligation are obliged to adopt risk mitigation techniques for such trades. This will include either the “timely, accurate

and appropriately exchange of collateral” or the appropriate and proportionate holding of capital against such trades. In

addition, the Proposed EU Regulation would impose requirements for electronic confirmation of trades (where possible) and

processes to reconcile portfolios, to manage risks, to identify and resolve disputes and to monitor the value of outstanding

contracts.

Reporting The Proposed EU Regulation imposes reporting obligations on both financial counterparties and non-financial counterparties.

Financial counterparties are required to report on all OTC trades (whether or not cleared) to a trade repository or if a trade

repository cannot record the details of the contract, then report directly to their home state regulator. They would also need to

report any modifications and terminations of contracts.

Non-financial counterparties would be subject to a reporting obligation where they take positions that exceed a specified

“information threshold”. They must also notify the relevant regulator that they have become subject to the obligation and

provide a justification for exceeding this threshold.

As is the case with the clearing threshold, the EU Commission is responsible for determining the information threshold taking

into account the systemic relevance of the sum of net positions and exposures by counterparty per class of contract. However,

unlike the clearing threshold, hedging contracts are fully taken into account in deciding whether a non-financial counterparty’s

positions exceed the information threshold.

The detailed information (including the identity of the parties to a swap) held by a trade repository will be available to EU

regulators. Currently, the Proposed EU Regulation does not contain any provisions relating to access to information by non-EU

regulators and authorities. In addition, trade repositories will be required to publish aggregate positions by class of derivatives

on the contracts reported to them.

Regulation of central counterparties CCPs that offer clearing services are also subject to the provisions of the Proposed EU Regulation.

Access The Proposed EU Regulation requires CCPs to accept eligible contracts on a non-discriminatory basis, regardless of execution

venue. CCPs must also have non-discriminatory transparent and objective admission criteria for admission of clearing members

to ensure open access. However, the Proposed EU Regulation accepts that unfettered access could be an issue (i.e. where

anyone can be a clearing member – this would affect the financial integrity of the clearing house) and so a CCP is permitted to set

criteria relating to financial resources, operational capacity and other criteria where the objective is to control risk.

Authorisation and supervision CCPs will take more central role and, by the nature of clearing, CCPs will take on credit risk with a concentration of credit risk

in CCP.

The Proposed EU Regulation requires any CCP established in the EU to be authorised in its home state. The Proposed EU

Regulation also sets out provisions governing capital requirements for CCPs – including requiring CCPs to hold at least EUR 5

million of regulatory capital. The Proposed EU Regulation also contains provisions relating to oversight and withdrawal of

authorisation and co-operation between authorities, including provisions on the exchange of information and professional

secrecy.

While the Proposed EU Regulation does not go so far as to impose limitations on ownership (unlike the US Dodd-Frank Act),

the Proposed EU Regulation does give power to the home state regulator to assess suitability of anyone with direct or indirect

holding of 10% or more of the capital/voting rights of a CCP.


13


Segregation and portability of assets and positions The Proposed EU Regulation also contains conduct of business rules applying to CCPs. One of the significant provisions

relates to segregation and portability of assets and positions.

In the Lehman aftermath, many counterparties who had entered into transactions and placed collateral for cleared (and

uncleared) transactions with Lehman Brothers found themselves in a situation where they could not easily move their positions

to new traders or move their collateral without going through the relevant insolvency official. These requirements are aimed at

avoiding these issues in a similar situation.

As such, the Proposed EU Regulations require CCPs to ensure that each clearing member distinguishes and segregates client

positions from its own assets, CCPs to segregate collateral received from its own assets, CCPs to keep records and accounts

to identify and segregate the assets and positions of one clearing member from those of another clearing member and the

CCP. In addition, clearing members are to offer their clients the ability further to have a more detailed segregation of assets so

that CCPs will be able to “port” positions from one clearing member to another clearing member who has agreed to take on the

position (e.g. on the default of the first clearing member).

To give effect to these requirements, the Proposed EU Regulation states that these requirements will prevail over any

conflicting laws, regulations and administrative provisions of the member state that would otherwise prevent them. This is

intended to disapply any national insolvency rules which would obstruct the transfer of client assets away from an insolvent

clearing member.

The Proposed EU Regulation also contains provisions dealing with defaults and use of collateral. One interesting requirement

is that with respect to margin provided by clearing members, a CCP is required to ensure that the margin received by it is

protected from the insolvency of the CCP itself. If this provision goes into the final version of the Regulation, then clearing

houses may need to revisit their existing treatment of margin where this conflicts with such requirement.

Transitional provisions The Proposed EU Regulation is silent as to whether the clearing obligation and the risk management obligations apply to

existing OTC derivatives contracts. However, it specifies that existing contracts will need to be reported to trade repositories

(or failing which the relevant regulator).

Who is impacted by the proposed EU regulation? As with the Dodd-Frank Act, the Proposed EU Regulation is clear in some instances and unclear in others as to who is

affected by its provisions.

It is clear that the clearing, reporting and risk management obligations will apply to financial counterparties incorporated and

authorised in the EU and to non-financial counterparties incorporated in the EU whose positions in OTC derivatives exceed the

relevant thresholds. It also seems likely that the same obligations will apply to EU branches of non-EU financial counterparties,

such as EU branches of Asian banks.

It is unclear how the Proposed EU Regulation is to apply where an EU fund manager enters into OTC derivatives transactions

on behalf of an underlying client. It seems to be intended that its provisions should apply where an EU fund manager enters

into an OTC derivatives transaction on behalf of an EU or non-EU alternative investment fund (e.g. a hedge or private equity

fund). However, it is unclear whether the provisions apply where an EU fund manager is acting on behalf of a segregated

account for a non-EU underlying client.

It is also unclear whether the same obligations will apply to transactions entered into by non-EU branches of EU institutions

(e.g. OTC derivatives transactions entered into by the Asian branches of EU banks).

In addition, it is currently unclear whether the Proposed EU Regulation is intended to apply directly to non-EU incorporated

financial counterparties acting outside the EU (perhaps, e.g. if they trade directly with EU counterparties). However, in any

event, the original proposed text of the Regulation would impose the clearing, reporting and risk management obligations on

EU counterparties when they enter into an OTC derivatives contract with any non-EU entity, although this is likely to be cut

back to a narrower group of non-EU counterparties.



Implications for Asian institutions Whilst there is a considerable degree of uncertainty, there can be no doubt that the effects of regulations being proposed in the

US and in Europe will extend across the globe, including in Asia. The very fact that there is uncertainty about how the rules will

be implemented - both within and outside these jurisdictions - will have a significant effect on the market.

Volcker Rule – Impact on banks in Asia The Volcker Rule will apply to banking group entities of a US headquartered banking group no matter where they are located

and so the rule will restrict the proprietary trading (and private fund activities) of US banking group entities in Asia (such as the

Asian branches and subsidiaries of US banks).

The Volcker Rule will also apply to Asian and other non-US banks with branches or agencies in the US. The US offices and

affiliates of the non-US bank will be caught directly by the Volcker Rule. For non-US offices and affiliates of such non-US

banks, including those in Asia, proprietary trading would only be permitted so long as it occurs solely outside the US, whereas

sponsoring or investing in private equity or hedge funds would be permitted, only so long as the activity is done solely outside

the US and the private equity or hedge funds are not offered or sold to US residents. In each case, the exemptions for non-US

activity are only available to a banking group entity that is not owned by a US entity.

US registration requirements Asian institutions will also be concerned about whether they might be required to apply to be registered as a swap dealer or a

major swap participant in the US under the new registration requirements, in particular because of the capital and conduct of

business obligations that may apply to them as a result (as well as the extension of US regulatory jurisdiction over their

activities). It seems likely that these issues will mainly arise where an Asian institution deals in OTC derivatives with a US

counterparty but many Asian institutions do trade OTC derivatives with US institutions (e.g. US banks) and will be concerned

that their activities may now bring them within the scope of US registration requirements.

US Push-Out Rule The US Push-Out Rule could affect Asian banks if they have a branch in the US and trade in OTC derivatives through that

branch, in particular as the exceptions to the Push-Out Rule are not available to US branches of foreign banks.

The rule could also affect a number of Asian institutions that trade in OTC derivatives directly with the principal US banking

entity in a US bank group. They may now be requested to deal with a new group company (perhaps with a different credit

rating), which may also affect their ability to net their exposures if not all their swaps business is booked with the same

counterparty.

Clearing, risk management and reporting requirements Asian institutions will also be affected by the clearing, risk management and reporting requirements in the Dodd-Frank Act and

the Proposed EU Regulation. These issues are most likely to arise where an Asian institution trades in OTC derivatives with a

US or EU entity, such as a US or EU bank or other dealer. The requirement for trades to be cleared and reported and for the

provision of margin will undoubtedly result in an increased operational and compliance burden and increased costs.

Even if an Asian institution is not characterised as a dealer or major swap participant for the purposes of the Dodd-Frank Act, it

may be subject to obligations under the legislation if it deals in OTC derivatives with a US dealer. If the swap is eligible for

clearing, it seems likely that the swap will need to be traded through a SEF and submitted to clearing unless the Asian

institution can bring itself within the exemption for non-financial entities engaging in hedging activities. However, the end-user

exemption would involve the Asian institution notifying the CFTC or the SEC of its reliance on the exemption (by giving notice

to a data repository, according to proposed regulations) and how it generally meets its financial obligations (and so may not be

an attractive option to some Asian institutions). If the swap is not eligible for clearing then the US institution may be required to

insist that the contract be margined. In any event, the contract will have to be reported to a swap data repository.

In contrast, if an Asian institution trades in OTC derivatives with an EU bank or other dealer, as the Proposed EU Regulation is

currently drafted, the EU dealer would be required to insist on the contract being cleared with a CCP, if the contract is eligible

for clearing under the Regulation (although it is possible that the Proposed EU Regulation may be changed to allow

exemptions where the non-EU entity is not a financial counterparty and its positions are below the clearing threshold). Even if

the contract is not eligible for clearing, the EU dealer may be required to margin the transaction or to hold appropriate capital


15


against it (the requirements for which await implementing standards). In any event, the EU dealer may be required to report

the transaction to a trade repository or its local regulator.

While the focus is likely to be on those cases where Asian institutions face US or EU dealers in relation to OTC derivatives

transactions, there may be other situations where the clearing, risk management and reporting obligations affect Asian

institutions. For example, there is no express exemption in either the Dodd-Frank Act or the Proposed EU Regulation for intra-

group transactions, although this is under consideration in both the US and the EU.

The reporting requirements may give rise to confidentiality concerns for Asian institutions that trade with US or EU

counterparties. They may be concerned about the broad range of international regulators and authorities that may be able to

obtain information from swap data/trade repositories about their trading activities. To the extent that the Asian institution is

itself acting on behalf of an underlying client, there may also issues as to whether the disclosure is consistent with the

confidentiality requirements applicable to the Asian institution. For example, Singapore has strict banking secrecy laws. Care

will need to be taken that no breach of confidentiality obligations would occur, as such a breach could lead to regulatory

sanctions, criminal penalties and/or breach of contract.

Existing transactions One particular concern for Asian institutions will be how the new laws will affect existing transactions.

Under the Dodd-Frank Act, Asian institutions will not be required to clear existing swaps with US counterparties, but these

swaps will have to be reported to US swap data repositories. Also, the treatment of these existing swaps for margin purposes

is not entirely clear: the Dodd-Frank Act requires dealers to impose margin and does not include an explicit exemption for

swaps in existence before the Dodd-Frank Act goes into effect.

The Proposed EU Regulation is silent as to whether the clearing or the risk management obligations apply to existing OTC

derivative transactions. This is currently being debated. However, as in the US, the Proposed EU Regulation would require

existing OTC derivative contracts to be reported to trade repositories (or to EU regulators)

Asian CCPs and trade repositories Where the US or EU rules require trades to be submitted for clearing or reported to a trade repository, an Asian institution may

wish to ensure that an Asian CCP or trade repository is used for this purpose, especially if the Asian institution is subject to

clearing and reporting obligations in its home state which require them to use a domestic CCP or trade repository. Both the US

and the EU legislation provides a means to allow the use of Asian CCPs, as they both allow the regulators to

exempt/recognise foreign CCPs that are subject to comparable/equivalent regulation. However, it could be some time before

this is permitted and so it is possible that there could be a conflict between the clearing requirements applicable to the EU/US

counterparty and the Asian institution.

With respect to trade repositories, the Proposed EU Regulation allows ESMA to recognise non-EU trade repositories, but only

if there is a treaty in place allowing the sharing of information with EU regulators. The Dodd-Frank Act allows non-US swap

data repositories to register in the US, but the requirements with respect to access to data may make it difficult for them to do

so.

Uncertainty about unresolved issues The EU and US proposed reforms leave many in the industry facing a continued period of uncertainty: there is uncertainty over

the extraterritorial cross-border application of the proposals; and as the rulemaking process under both regimes will not be

finalised for some time - July 2011 in the case of the US reforms and 2012 in the case of the Proposed EU Regulation - this is

likely to continue for some time.

There are also, as mentioned, some key differences between the approaches taken in the US and Proposed EU Regulation.

This will certainly be a test of co-ordination - although regulators on both sides will be incentivised to so as not to create

regulatory arbitrage.

Potential opportunities for Asian institutions? The increased regulation of OTC derivatives in the US and the EU, as compared to the continued relatively light-touch

approach in Asian jurisdictions, has caused many to ask if this will mean potential opportunities for Asia.



This will require some crystal ball gazing. However the following important factors will determine if such perceived

opportunities can be brought to fruition and we pose them as concluding thoughts to this memorandum:

■ Will Asian institutions be able effectively to ring-fence themselves from the US and EU regimes?

■ Is there enough appetite for market players to relocate derivative activities to Asia or will market participants accept the

increased costs/complexity as part of their business and seek to pass on any attendant costs to end-users?

■ Are Asian regulators prepared for migration of trading activity to the region? Would they be prepared to take on the “too

big to fail” and potential bailout issues, in particular in respect of foreign players?

■ What regulations will Asian regulators implement in respect of obligations under G20 (e.g. Japan) or, in the case of non-

G20 Asian countries (such as Hong Kong or Singapore) because they feel they must or should do, and how will these

compare to the US and EU regimes?

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* Clifford Chance also has a co-operation agreement with Al-Jadaan & Partners Law Firm in Riyadh and a 'best friends' relationship with AZB & Partners in India and with Lakatos, Köves &

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