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Derivatives Compliance

In the aftermath of the 2008/2009 financial crisis, global regulatory reforms for derivatives from both Dodd-Frank in the U.S. and EMIR in Europe have been broad-ranging and transformational. Blue Rose stays informed of the latest changes so that we can guide our clients through the new regulatory and documentation requirements and assist with the implementation of operational best practices.

Legal Entity Identifier (LEI)

After the global financial crisis of 2008-2009, regulators realized that a standardized tool was needed to identify entities that participate in the global financial markets. The Legal Entity Identifier or “LEI,” is a unique code that is assigned internationally to a single firm or organization involved in a financial transaction using a standard format in accordance with the ISO 17442 standard. The LEI has been endorsed by regulators worldwide, it allows transactions to be reported in a consistent manner anywhere in the world, and it enhances market transparency by enabling transactions and risk to be analyzed on a global basis. 

ISDA Protocols​

The International Swaps and Derivatives Association (“ISDA”) develops and maintains industry standard documentation (“ISDA documentation”) used worldwide by derivatives industry participants. As the derivative markets grew and changed, ISDA started to issue protocols in 1998 to address industry standard legal and contractual changes for use by ISDA compliant parties. With the advent of new regulations after the 2008/2009 financial crisis, ISDA has issued a couple of protocols to help U.S.-based swap participants comply with the implementation of the Dodd-Frank Act: ISDA August 2012 DF Protocol and ISDA March 2013 DF Protocol. Both protocols are related to CFTC rulemakings. The August 2012 protocol addresses changes to existing documentation of the swap trading relationship. The March 2013 protocol also addresses existing documentation of the swap trading relationship but expands it to include covenants, representations, notices, and bilateral delivery requirements that respond to Dodd-Frank. The March 2013 protocol also includes a Protocol Questionnaire, which lets counterparties make certain elections related to their trading relationship under Dodd-Frank.

Dodd-Frank Exception to Mandatory Clearing and Execution Requirements

With the implementation of the Dodd-Frank Act, a new regulatory framework has been put in place to manage global systemic risks and create a more transparent derivative market. The Dodd-Frank Act required the establishment of centralized clearinghouses and mandatory clearing and reporting requirements for over-the-counter derivatives. However, Dodd-Frank also allows many swap market participants, such as municipal issuers, pension funds, and corporations, to receive an “end-user exception” from the mandatory clearing requirements. In order to elect the end-user exception, the following criteria must be met:

  • One of the counterparties to the swap must be a non-financial company (as defined by the Dodd-Frank Act),

  • The swap is being used by the electing counterparty to hedge or mitigate commercial risk, and

  • The electing counterparty must report the swap in accordance with CFTC swap reporting rules.

If the electing counterparty is an SEC reporting company, then it must report whether an "appropriate committee" of its board of directors has reviewed and approved the decision not to clear swaps in reliance on the end-user exception. Such decision must be reviewed and approved at least annually and more frequently if there is a change in hedging strategy.

It should be noted that the end-user exception is optional and a non-financial entity can decide that it is not in its best interest to rely on the end-user exception for every swap transaction.

Tax Compliance for Derivatives

Some end-users have elections to make and tax regulations to follow which require them to consider specific IRS rules related to derivatives and associated borrowings. Blue Rose is experienced in these tax regulations and works with tax counsel to accomplish full tax regulatory compliance.

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