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The DoddThe Dodd--Frank Act: 5 Key Issues for Position LimitsFrank Act: 5 Key Issues for Position Limits

Thomas J Lord | Advisory | PricewaterhouseCoopers | Telephone: +1 720 931 7388 | Mobile: +1 719 332 6813 | [email protected]

Jeffrey A. ShermanFulbright & Jaworski L.L.P.Telephone: +1 202 662 [email protected]

Today’s SpeakersToday’s SpeakersToday’s SpeakersToday’s Speakers

Thomas J Lord Jeffrey A Sherman

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Advisory PricewaterhouseCoopers

Telephone: +1 720 931 7388Mobile: +1 719 332 6813

[email protected]

Jeffrey A. ShermanFulbright & Jaworski L.L.P.

Telephone: +1 202 662 [email protected]

CFTCCFTC--Imposed Position Limits: OverviewImposed Position Limits: Overview

ExemptionsExemptions28 Core 28 Core

ContractsContracts

“Bona fide” hedgers and "pass-through" entities

151.5(a) definition: (1) a substitute for a physical market transaction and (2) enumerated hedge list

Form 404, 404A, 404S; monthly reporting of daily

Federal limits on 28 core futures contracts – 19 agricultural, 5 metal, and 4 energy futures contracts (crude oil, heating oil, gasoline, and natural gas) and economic equivalents

CFTC has authority to set position limits, as “appropriate” to prevent “excessive speculation,” on all futures and swaps traded on an exchange or swap execution facility, and off-exchange swaps that perform a significant price-discovery function

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Position & Position & Account Account

AggregationAggregationMethodology Methodology

& Phasing& Phasing

monthly reporting of daily positions

Initial transitional phase establishes spot-month position limits based on DCM levels (Appendix A)

Phase 2 will include spot-month positions based on 25% deliverable supply and non-spot limits based on 10% + 2.5% open interestInterim rule comments due: 1/17/12

Aggregation of futures, economically equivalent swaps, and contracts on U.S. DCMs, SEFs and FBOTs that settle against a U.S. listed contract

Aggregation of affiliate accounts(>10% interest or common control: exemptions: commodity pool, ICA, FCM, underwriting, fed. law)

Addresses DCM & SEF-traded contracts

Final Rules & Final Rules & Interim Final Interim Final

RuleRule

Position Visibility RegimePosition Visibility Regime

Applicable Contracts

Reporting

Applies to traders exceeding any of the 5 metals or 4 energy “referenced contracts”

Traders exceeding net long/short “visibility” levels must report positions to the CFTC in a Form 401 and 404 (or electronic spreadsheet)

Proposed position visibility rules are designed to enable the CFTC to identify and monitor the positions of the largest traders

Data Keeping Implications

Must file quarterly, but must show daily positions, among other things

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OtherReferenced NYMEX Energy Commodity Contract Visibility Level

Light Sweet Crude Oil (CL) based on a trading unit of 1,000 U.S. barrels (42,000 gallons) delivered at the Cushing crude oil storage complex in Cushing, Oklahoma 50,000

NY Harbor Gasoline Blendstock (RB) based on a trading unit of 1,000 U.S. barrels (42,000 gallons) delivered at an ex-shore facility in New York Harbor 10,000

Henry Hub Natural Gas (NG) based on a trading unit of 10,000 million thermal units (mmBtu) delivered at the Henry Hub pipeline interchange in Erath, Louisiana 50,000

NY Harbor No. 2 Heating Oil (HO) based on trading units of 1,000 U.S. Barrels (42,000 gallons) delivered at an ex-shore facility at New York Harbor 16,000

Five Key Position Limit Compliance Issues Five Key Position Limit Compliance Issues

What contracts are referencedcontracts?

•28 core contracts ( 151.2) & "economically equivalent" swaps, options ( 151.1 referenced contract definition). Excluded: financial basis & commodity index Ks.•“Directly or indirectly" linked to (i) core futures or (ii) price of same commodity underlying a core futures contract for delivery at the same location or locations

•E.g., (1) contracts priced at a fixed differential to a core futures; (2) look-alikes (settle off of a core or same commodity @ same location); (3) contracts based only on combination of a referenced K(s) price and price(s) of same/substantially same commodity; (4) intercommodity spread contracts (Rules Preamble 71,630-31)

(1) Translating your understanding of your portfolio to the CFTC's position limit definitions

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Clear as mud?

•Definition of referenced contracts “are based on objective criteria and readily available data, which should provide market participants with clarity as to the scope of economically equivalent contracts” (71,631)•Oddities: Henry fin. basis = no, but Henry Hub daily-for-monthly index swap = yes;Henry IFERC index phys = no, but Henry IFERC index cash-settled = yes;Henry fixed-for-IFERC index swap = yes, but TranscoZ1 fixed-for-IFERC index swap = no; what about Col. Gulf?

• What system is every trade in?• What table in that system?

• Translating to reference contractsTagging existing trades

Finding the “portfolio”

(1) Translating your understanding of your portfolio to the CFTC's position limit definitions


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• Tagging existing trades• Tagging new trades

• Creating the look up tables• Communicating across systems/countries/companies• Compiling the portfolio

Tagging theBase Data

Creating the report


AggregationRules

( 151.7)

•CFTC clarified that aggregation policy applies to swaps + futures/options•An entity must aggregate accounts if it:

•(i) directly or indirectly holds positions, controls trading, or has a 10 percent or greater ownership or equity interest, (ii) is acting pursuant to an expressed or implied agreement or understanding with respect to an account or accounts, or (iii) holds or controls the trading of positions in multiple accounts (including in multiple trading pools) with identical trading strategies

•Must aggregate all owned/controlled accounts: •"including accounts held by entities in which that trader owns a 10 percent or greater equity interest. Thus, for example, a financial holding company is required to aggregate house accounts (that is proprietary trading positions of

(2) Aggregating Accounts: who owns the data, how do you get it, and are you allowed to see it?

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Exceptions toaggregation

required to aggregate house accounts (that is, proprietary trading positions of the company) across all wholly-owned subsidiaries" (Rules Preamble 71,651)

•commodity pool participants;•futures commission merchants (“FCM”); •"Independent Account Controller” (“IAC”); •underwriting; and •federal law/regulation information restrictions (e.g., "FERC affiliate rules, bank regulatory restrictions, and antitrust provisions" –71,652)

•entity must not have "actual knowledge of information associated" with positions; opinion of counsel required ( 151.7(i))

• How do you segregate positions?• What about individual utilities within a firm – do 880 standards

(e.g., as revised in Orders 2004 & 717) apply across multiple 880 affiliates?

• How do you get your multiple systems to talk?• Implications for multi-national firms• How do you push data to multiple desks?

FERC 880

Systems

Five Key Position Limit Compliance Issues Five Key Position Limit Compliance Issues (2) Aggregating Accounts: who owns the data, how do you get it, and are you allowed to see it?

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• How do you push data to multiple desks?

• How do I push intra-day or end of day information to a 10% owner?

• What about joint owners in an SPV that are both industry participants?

• What if an operating contract sequesters data?

Systems

What aboutmy owners


Rules on counting positions

•Futures + options + swaps on a "futures equivalent" basis (see Large Trader Reporting rule, Appendix A, 76 Fed. Reg. 43,851); •Netting rules ( 151.4(c)): spot month cannot net phys/fin (Henry NG included)•Aggregation across platforms (including FBOTs) ( 151.4, 151.8) and all affiliate accounts ( 151.7)•Bona-fide hedge exemptions (higher limits) ( 151.5)

(3) How do you calculate your position and what do you do if you exceed the limits?

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Exceeding limits without

bona-fide hedge

•No “scienter” (intent) required for violation•How fast will your system alert you to a violation? What if your affiliate provides an understated position?

•2+ day violation could net $100,000s settlement fines•DCMs and SEFs monitor positions; current exchange rules permit 1 day to liquidate or obtain hedge exemption; what happens to those rules & compare to CFTC timing rules to file 404, 404A, 404S

• Utilize the reference contract and aggregation rules• How to apply balance of month allocation to OTC swaps?• What “risk factor” do you use?• What about ring fenced swap dealers?

Calculation methodology

Five Key Position Limit Compliance Issues Five Key Position Limit Compliance Issues (3) How do you calculate your position and what do you do if you exceed the limits?

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• Do you report a violation to the SRO or CFTC?• Can you anticipate individual SEF/DCO/DCM reporting and

data regimes?• What is the timing of violation reporting? Whistleblower

Reporting


Complying with the limits

•Position limits applied on an intraday basis (Rules Preamble at 71,643)•This directive aimed at policing very large speculative positions, regardless of whether they "persist to the end of the trading day"

•CFTC acknowledges that intraday requirement, which applies to all aggregated positions pursuant to aggregation rules (71,652), can cause problems for entities with real-time information sharing restrictions – hence the federal law exemption to aggregation

(4) When must you calculate and report your position: trade order, trade execution, intra-day, end-of day?

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Filing reports, etc.

•Form 401 (visibility reports; 10 business days after quarter where levels are exceeded; positions reported are end-of-day; must include a 404 for cash market information as per 151.6)•Form 404 (9 a.m. on 3rd business day after position exceeds limit; monthly reports of daily positions (71,682) calculated as of end-of-day):•Form 404A (10 business days before exceeding limit or any increase, but may notexceed 1 year agric/anticip. merchandising)•Form 404S (9 a.m. on 3rd business day after position exceeds limit; monthly reports of daily positions calculated as of end-of-day)•“Pass-through” swaps: bona-fide hedger’s representation to its counterparty must be made at trade “inception (i.e., execution)” which “may be made in a trade confirmation” (71,648) and must be kept for 2 years ( 151.5(i))

• Order level data – who has it?• Trade executions – many companies have STP (straight

through processing) on ICE contracts but not NYMEX• Do you have an aggregation exemption?

What does the limit cover?

Five Key Position Limit Compliance Issues Five Key Position Limit Compliance Issues (4) When must you calculate and report your position: trade order, trade execution, intra-day, end-of day?

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• Order level implies real time – other choices?• Futures Equivalent means role up – what is your trade entry

cycle – especially important for non swap dealers• Tagging new trades

Calculationcycle


404 (form from CFTC)

151.5(c)

•Descriptions: The date of the hedging position; which hedge; which cash market commodity hedged•Data: (1) quantity of stocks in cash market commodity; (2) quantity of fixed-price purchase commitments of the cash market commodity; (3) sum of 1 & 2; (4) quantity of fixed-price sale commitments of the cash commodity; (5) quantity of long and short Referenced Contracts (futures equivalent basis), in the nearby contract month that are being used to hedge the long and short cash market positions; (6) Total number of above; and (7) cross-commodity hedging information.

•Descriptions: anticipated cash market commodity to be hedged; how ref. contracts

(5) When and how do you make 404 filings (Forms 404, 404A, 404S)?

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404A (form from CFTC)

151.5(d)

meet 151.5(a)(1); units; time period of hedge (not to exceed 1 year for agricultural Ks & anticipated merchandising hedge);•Data: (1) actual use, production, merchandising, etc. for last 3 fiscal years; (2) anticipated use, production, merchandising requirements, etc. for period; (3) unsold anticipated production or unfilled requirements; (4) max. number of ref. contracts;(5) for antic. merchandising, description of storage facility, antic. capacity; current inventory & total capacity for 3 fiscal years; (6) cross-commodity information

404S (form from CFTC) 151.5(i)

•Descriptions: date; commodity reference price (price series used in swap); notional quantity of swap; units of measurement•Data: (1) gross long or short position that qualify as bona-fide hedge

• Where did they hide the cheese?• http://www.reginfo.gov/public/do/PRAICList?ref_nbr=201111-

3038-001

• 404• 404 – Position or Visibility Limit exceeded by you

Finding the Report Forms

Five Key Position Limit Compliance Issues Five Key Position Limit Compliance Issues (5) When and how do you make 404 filings (Forms 404, 404A, 404S)?

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404 Position or Visibility Limit exceeded by you• 404 A – 10 day pre-filing for anticipatory hedging – need

historical data• 404 S – relying on customer bona fide hedge for pass through

exception• 401 – Visibility Limit only – in addition to 404 filing; alternative

possible (e.g., spreadsheet) upon CFTC approval

Filling out the Report

Producer Consumer

Physical Gas

Physical Gas

Inside FERC Floating Price

Bona Fide Fact Pattern #1 Bona Fide Fact Pattern #1 –– Moving from Float to FixedMoving from Float to FixedBona Fide Fact Pattern #1 Bona Fide Fact Pattern #1 –– Moving from Float to FixedMoving from Float to Fixed

Financial Swap

Financial Swap

Inside FERC Fixed Price

Producer Third PartyNYMEX Fixed Price SWAP

Direction of arrow indicates direction of trade: from Seller to Buyer

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What You Can Do What You Can Do RIGHT NOWRIGHT NOW to Prepare for Doddto Prepare for Dodd--FrankFrank

Assess you and your affiliates’ trading

• Assess whether modifications to systems are needed to track positions

• Identify affiliate systems and make sure systems permit

Assess your data systems

Bona Fide Hedge Assessment

• Establish compliance verification and correction protocols

• Fast auditing/ checking of positions

• Notification

Violations

• If rely on “bona fide” hedging exemption:

• establish protocols for managing your 404, 404A, 404S deadlines;

• Get the data you need• Create system for

• What do you trade?

• What do all your 10% affiliates trade?

• Do you hedge? If so, what and do you qualify for exemption?

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Dodd-Frank will impact your front, mid, and back offices – Preparation could take significant time and require systems modifications

you to calculate and aggregate positions

• Develop internal notification system when approaching limits

• Modifications to risk management policies, trading limits, or trading strategies

Notification procedures

• Liquidation procedures

Create system for monthly reporting of end-of-day daily positions

• For 404S filers, check representations

• For 404A filers, create pre-filing control process; note 1-year limits for some hedges

exemption?

• End-users not exceeding limits may need to calculate & monitor bona-fide hedges for making representation to 404S filers

Financial Reform Task Force

Peggy A. Heeg +1 713 651 8443

[email protected]

Michael L. Loesch +1 202 662 4552

[email protected]

Thomas J Lord | Advisory | PricewaterhouseCoopers | T l h +1 720 931 7388 |

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Jeffrey A. Sherman+1 202 662 4573

[email protected]

Telephone: +1 720 931 7388 | Mobile: +1 719 332 6813 | [email protected]

the international firm of fulbright & jaworski l.l.p. - dodd … · today’s speakers thomas j...

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