Posts by: Editorial Board

ISDA Protocol Address Eurozone Capital Control Risk

Posted on

 

For some time now, market participants have been concerned about the exit of a member-state from the Eurozone. These concerns are most acute in—but not limited to—the case of Greece, as it struggles to implement structural reforms demanded by its troika of lenders: the European Central Bank, the International Monetary Fund and the European Commission. As part of its Eurozone contingency planning, the International Swaps and Derivatives Association, Inc. (“ISDA”) has attempted to address some of the risks relating to derivatives transactions in the event such an exit occurs through the publication on July 11th of the Illegality/Force Majeure Protocol (the “Protocol”).[1] The purpose of the Protocol is to facilitate the amendment of 1992 ISDA Master Agreements with the more sophisticated “Illegality” and “Force Majeure” provisions of the 2002 ISDA Master Agreement. READ MORE →

IRS Amends Temporary Treasury Regulations Under Section 871(m)

Posted on

 

On August 31st, the U.S. Internal Revenue Service amended Temporary Treasury Regulations under Section 871(m) of the U.S. Internal Revenue Code of 1986, as amended, that were originally issued on January 23, 2012, postponing the effective date for the new regulatory scheme contemplated by Proposed Treasury Regulations also issued on January 23, 2012.  The Temporary Regulations now extend the definition of “specified notional principal contract” that is set forth in Section 871(m)(3)(A) to payments made before January 1, 2014.

Commentators on the Proposed Regulations have noted that they pose many challenges for the withholding tax system and expand the contexts in which a non-U.S. person may be required to act as a withholding agent.  It was further noted that Section 871(m) is principally aimed at arrangements that provide synthetic exposure to the full economic risk and reward of an underlying security (so-called total return or delta one transactions).  However, the Proposed Treasury Regulations could apply more broadly to other arrangements, including options and other instruments that are not economic substitutes for actual ownership.  In this regard, the amendment to the Temporary Treasury Regulations acknowledges that U.S. Department of the Treasury and the Internal Revenue Service received numerous comments that the proposed effective date of January 1, 2013, would not allow taxpayers enough time to build and test the systems required to implement the withholding rules for specified notional principal contracts.  In response to these comments, the amended Temporary Regulations effectively delay the applicability of the definition of “specified notional principal contract” that is set forth in the Proposed Treasury Regulations until January 1, 2014.  For additional information on this development, please click here.

Dodd-Frank Act Implementation Update

Posted on

 

Title VII of the Dodd-Frank Act, titled the “Wall Street Transparency and Accountability Act of 2010” (“Title VII”), was enacted on July 21, 2010.[1]  Under the Dodd-Frank Act, which is generally intended to bring the $700 trillion over-the-counter derivatives market under greater regulation, the Commodity Futures Trading Commission (“CFTC”) has primary responsibility for the regulation of “swaps” and the Securities and Exchange Commission (“SEC” and, together with the CFTC, the “Commissions”) has primary responsibility for the regulation of “security-based swaps.”  A summary of certain noteworthy developments in the implementation of Title VII since our last update follows. READ MORE →

City of Milan Settles with Banks in Derivatives Fraud Case

Posted on

 

The City of Milan, Italy, has reached a settlement relating to a dispute involving fees charged by four foreign banks relating to the sale of derivatives.  The City had entered into swaps with each of UBS AG, Deutsche Bank AG, JPMorgan Chase & Co. and Depfa Bank PLC that were linked to, among other things, a €1.68 billion bond issued by the City.  On April 27, 2009, Italian financial police, acting on the order of a judge, seized assets (including the banks’ stakes in certain Italian companies, real estate assets and bank accounts) valued at approximately €476 million from the four banks in connection with an investigation into whether the banks fraudulently received some €100 million in fees which were not properly disclosed.  Subsequently, on March 17, 2010, public prosecutors formally charged the four banks, as well as eleven bankers and two former city officials, with fraud in connection with these transactions.[1]

Under the terms of the €455 million settlement deal, the banks reportedly will unwind the transactions and pay to the City the current mark-to-market of the swaps, with a substantial discount.  In exchange, the City agreed to release certain seized assets and drop claims for damages in a civil suit it had brought.  The City also agreed to withdraw as a plaintiff in the related criminal suit, although that case is continuing in the Italian courts.  The banks did not admit any responsibility in connection with their fees as part of the settlement

[1] For additional information regarding these transactions and the related investigation, click here and here.

Greece Triggers Credit Event and Raises Questions for Sovereign CDS

Posted on

 

On March 9th, the ISDA Determinations Committee for Europe unanimously concluded that The Hellenic Republic (Greece) had triggered a restructuring “credit event” under credit default swap (“CDS”) contracts in connection with the exchange of its debt with private creditors.  The committee’s determination was based in large part on the imposition and use by Greece of retroactive “collective action clauses” (“CACs”) on bonds governed by Greek law which bound all holders of such debt to the decisions of a supermajority.  In accordance with the 2003 ISDA Credit Derivatives Definitions, a restructuring credit event (whether due to a reduction of coupon, extension of maturity or other specified change) is not triggered unless the restructuring “occurs in a form that binds all holders.” READ MORE →

Investment Management Industry Challenges CPO Registration Requirement

Posted on

 

On February 9th, the CFTC issued a final rule modifying its Rule 4.5 to require the advisers of an investment company registered under the Investment Company Act of 1940, such as a mutual fund or exchange-traded fund, to register as commodity pool operators (“CPOs”) if, generally, the fund invests a material amount of its assets in speculative commodity futures, options and swaps.[1]  On April 17th, the Investment Company Institute and the U.S. Chamber of Commerce filed suit in the United States District Court for the District of Columbia, challenging the rule as “arbitrary and capricious” and asking for injunctive relief to prevent its implementation.  The investment management industry has objected to the new requirements from when they were first proposed, arguing that regulation by the CFTC would be burdensome, expensive and unnecessary because registered investment companies are already subject to regulation by the SEC.  Among other things, the suit contends that the CFTC failed to conduct an appropriate cost-benefit analysis in connection with the proposed rule and that the CFTC “nowhere explained or determined in any manner that SEC regulation was proving to be insufficient.”

[1] Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations; Final Rules, 77 Fed. Reg. 11252 (Feb. 24, 2012).

Standardization of Muni CDS

Posted on

 

On March 5th, ISDA published the 2012 ISDA U.S. Municipal Reference Entity Supplement to the 2003 ISDA Credit Derivatives Definitions (the “March 2012 Supplement”), which is intended to standardize credit default swaps referencing U.S. municipal issuers or obligations as the reference entity or reference obligation (“muni CDS”) with credit default swaps referencing corporate and sovereign CDS.  The March 2012 Supplement generally applies to muni CDS certain industry standards that became applicable to corporate and sovereign CDS through the 2009 ISDA Credit Derivatives Determinations Committees, Auction Settlement and Restructuring Supplement to the 2003 ISDA Credit Derivatives Definitions, which was adopted by the vast majority of the market through the “Big Bang Protocol.”[1] At the time the Big Bang Protocol was implemented, the market focus was on standardizing the terms of the corporate and sovereign CDS sectors, which were much larger in comparison.  Since that time, the trading volume of the muni CDS market has grown significantly, as has market interest in trading products that are liquid, fungible (generally, easier to offset with one another), and have the characteristics necessary for central clearing.

The March 2012 Supplement generally subjects muni CDS to the resolutions of the ISDA Determinations Committees, mandatory auction settlement processes and “look-backs” on credit events and succession events by incorporating the Big Bang Protocol.  Among other things, through the March 2012 Supplement, muni CDS transactions have been brought under the jurisdiction of the existing ISDA Determinations Committee for the Americas, which is the body that, inter alia, determines whether a credit event or succession event has occurred.  Moreover, the auction mechanism for determining the “final price” of assets in connection with a credit event has been hardwired into muni CDS contracts, with cash settlement becoming the standard settlement method.  Also, the Determinations Committees Rules have been amended in connection with muni CDS, such that: (i) holding an auction is mandatory where at least 3 dealers (as opposed to at least 5 dealers for corporate and sovereign CDS) are parties to 300 or more trades; and (ii) if one of the top 6 dealers by trading volume in single-name muni CDS and the Markit MCDX index (i.e., an index comprised of 50 U.S. municipal credits, encompassing both general obligations and revenue obligations) fails to participate in an auction, then that dealer will be removed from the Determinations Committee for purposes of making muni CDS determinations.

To further facilitate the standardization of the muni CDS product, the dealer community has modified certain trading conventions in conjunction with the March 2012 Supplement, including providing for standardized fixed coupons of 100 basis points and 500 basis points, which is the same convention used for North American corporate names.  All provisions of the March 2012 Supplement became effective on April 3rd, except for those relating to the look-back periods, which will become effective on June 20, 2012.  However, the terms of the March 2012 Supplement also became applicable to muni CDS entered into prior to April 3rd if the counterparties thereto both elected to adhere to the 2012 ISDA U.S. Municipal Reference Entity CDS Protocol.  Over 100 market participants signed up to this protocol during the period for adherence, which opened on March 5th and closed on April 2nd.

The March 2012 Supplement should make muni CDS more liquid and encourage trading.  From initial data, it appears that the enhanced standardization has indeed succeeded in increasing muni CDS trading volumes.  In fact, shortly after the terms of the March 2012 Supplement took effect on April 3rd, it was reported that trading volume in the Markit MCDX index increased to between $2 to 3 billion from a pre-standardization norm of between $500 million to $1 billion.  Despite this marked increase in trading activity, some have cautioned that a large and vibrant muni CDS market could make it easy for speculators to zero in on an issuer perceived as struggling, sharply impacting that issuer’s borrowing costs.

[1] For more information on the Big Bang Protocol, please click here.

Dodd-Frank Act Implementation Update

Posted on

 

Title VII of the Dodd-Frank financial reform, titled the “Wall Street Transparency and Accountability Act of 2010” (“Title VII”), was enacted on July 21, 2010.[1] Under Title VII, which is generally intended to bring the $700 trillion over-the-counter (“OTC”) derivatives market under greater regulation, the Commodity Futures Trading Commission (“CFTC”) has primary responsibility for the regulation of “swaps” and the Securities and Exchange Commission (“SEC” and, together with the CFTC, the “Commissions”) has primary responsibility for the regulation of “security-based swaps.” The Commissions share responsibility for the regulation of “mixed swaps.” A summary of several noteworthy developments in the implementation of Title VII since our last update follows. READ MORE →

Greece Inches Closer to Triggering a Credit Event

Posted on

 

With an enormous €14.5 billion bond maturing on March 20th, Greece continues to negotiate with its private sector investors on the reduction of approximately €100 billion of its total €350 billion of debt. Agreement with these investors is intended to reduce the country’s debt from 160% of GDP to 120% of GDP by 2020 and is required in order for Greece to secure from the European Union and International Monetary Fund the second installment of bailout funds, approximately €130 billion, necessary for the country to avoid default. However, the negotiations have been complicated and, perhaps, compromised, not only by Greece’s economic deterioration, but also, at least to some extent, by the involvement of smaller private investors who have purchased Greek debt—and, in some cases, credit default swap (“CDS”) protection on Greece—since the deal was announced in October 2011. At that time, the expectation was that approximately 90% of debt holders would voluntarily agree to the terms of the restructuring, which generally entailed an exchange of existing debt for new, longer-dated bonds. There is now concern that, as currently contemplated, significantly fewer debt holders will voluntarily agree to the proposed terms of the restructuring. One reason for this appears to be the purchase (at a deep discount) of large amounts of Greek debt from banks by funds and others more insulated from political and other pressures to accept a restructuring. This has resulted not only in a decline in debt holders willing to participate in an exchange of debt, but also in the tougher negotiation of terms for the new debt. READ MORE →

ISDA Publishes Industry Provisions for Collateral Segregation of Uncleared Swaps

Posted on

 

On December 6, 2011, the International Swaps and Derivatives Association, Inc. (“ISDA”) published sample tri-party provisions intended to assist market participants in the negotiation of provisions relating to the segregation of excess collateral, or “independent amounts.” The Dodd-Frank Act (the “Act”) imposes certain requirements for dealers to collect initial and variation margin from their counterparties. The sample provisions effectively provide market participants with suggested mechanics to implement Sections 724(c) (regarding “swaps”) and Section 763(d) (regarding “security-based swaps”) of Title VII of the Act, which generally require that dealers provide their end-user counterparties with the option of having independent amount collateral they deliver be segregated and held by a third-party custodian. READ MORE →