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A Mixed Bag of Compliance Activity - Dodd-Frank

London, 8 November 2012

CommodityPoint's New Dodd-Frank Market Research and Report: After almost two years of debate and public comment, the final rules for Dodd-Frank Title VII, the section of the regulations dealing with financial swaps and subsequently the commodity trading markets, were published by the U.S. Commodities Futures and Trading Commission (CFTC) in the summer of 2012.  Under the timeline established by the publication, new position limits regulations were scheduled to come into effect October 12, 2012 (though these limited were blocked in late Sept 2012 by a court ruling), and the swap data reporting regulations were set to come into effect January 1, 2013 for swap dealers and major swap participants. For those companies receiving an "end-user" status, the deadline for reporting is currently April 10, 2013.

Given these aggressive deadlines, it would be expected that market participants would undertake an equally aggressive program to ensure compliance - including such activities as swap data repository (SDR) onboarding, connectivity and testing; restructuring of internal processes to ensure proper data retention and reporting; and technology infrastructure changes.

In order to gauge the market's response to Dodd-Frank (DF) regulations, CommodityPoint undertook a study (sponsored by SAS RiskAdvisory) to look at the activities on the part of market participants in terms of Dodd-Frank readiness.  Our survey kicked-off in April of 2012 and ran through September.  In all, we had 47 net responses from companies trading in energy products, with most of those located in the United States, with a few others from Canada, Europe and Asia Pacific—companies that expected to have DF exposures as they were trading on U.S.-based exchanges or with U.S.-based counterparties.

It should be noted that, while not affecting the responses and data collected for this report, a couple of significant events occurred during the analysis and report writing phase of this research effort.  First, and as noted above, the position limit requirements for market participants were blocked by the U.S. District Court in Washington, DC, and secondly, the CFTC revised their deadline from Oct 12, 2012 to the end of the year for companies to declare their status as swap dealers.  These delays, along with other appeals and lawsuits that are working their way through the court systems, continue to create a confused outlook as to how or when the new Dodd-Frank regulations would ultimately be implemented.

Despite the protracted nature of the process, or possibly in light of the long delayed rule making (instilling doubt as to the eventuality of the regulations), many market participants have made little or no progress in developing their compliance processes or deploying the necessary technologies for compliance.  Within our group of respondents, a significant majority indicated they did have DF compliance initiatives underway, many (44% of the North American respondents) with teams of five or more internal resources assigned to the effort. Though fully 80% of the North American respondents indicated they did have some effort toward compliance underway, almost half the respondents (of those that knew their dollar spend to date) had actually spent less than $25,000 for outside services or technology to support the effort.

In terms of budgeted dollars for compliance activities (assumed through end of year 2012), more than 50% indicated they did not have any monies budgeted for DF compliance.  Nonetheless, 45% did indicate some level of budget, though of that group, budgets of less than $500k were most commonly noted.  In total, four of our respondents (three in North America and one outside the region) noted they had budgeted more than $2 million for the effort, with three of those being very large oil and gas producers and one large financial institution.  Of those that said they had no budget in place, these were most commonly those companies that held hard assets, including oil and gas producers and utilities; perhaps reflecting their belief that they would be classified as "End Users" and exempt from many of the regulatory burdens of Dodd-Frank.  That being said, it is important to note that while an "End Users" classification does change some reporting deadlines, it does not relieve those companies from all reporting and maintaining full life-cycle trade details.

In reviewing the data collected, there appears to be a general lack of urgency on the part of many market participants—low or no budgets, few resources assigned to compliance efforts, and little engagement with third parties that could provide expert opinion or technology solutions that could facilitate compliance.  Given the potential scale of the effort required to programmatically collect the volumes of data necessary to ensure compliance with DF regulations, we believe there is a significant risk that skilled resources (either CTRM vendor provided or those from CTRM-centric consulting firms) could be in very short supply.

Should Dodd-Frank rules implementation continue, as it appears it will, lack of movement by a significant number of market participants (especially in the "End-User" segment) is creating a large backlog of work across the industry and, we believe, this circumstance should be considered a significant risk as companies consider their compliance planning and efforts.  Additionally, as compliance will be a CTRM system-centric effort, companies that have held back moving forward to newer releases of their vendor supported CTRM solutions may face additional effort to upgrade those systems, as few vendors will "back code" Dodd-Frank specific capabilities (such as reports and new unique DF required data fields) to older versions of their products, especially those that are more than two or three generations old.  This version upgrade effort can, by itself, be very costly and time consuming, requiring months of effort even prior to full implementation of SDR connections or data collection, achieving and retrieval strategies.

Given the potential legal and financial exposures of non-compliance, we believe it should be incumbent upon all levels of leadership, from risk managers to C-level executives, to create a culture of Dodd-Frank compliance within their companies.  While many may think a manual work-around of the data reporting and retention requirements will be "good enough," such manual processes are prone to error and will most certainly evolve from being a high priority to one of a less urgent nature as the immediacy of the "business of the day" takes priority; after all, nothing bad will happen immediately if a trade doesn't get reported properly or if a report is late.  Unfortunately, while the regulators' response will not be immediate, it will most likely be aggressive once in motion; and once a company is identified as one that has not been compliant in the past, that company will likely remain on the CFTC's radar for a very long time.

As with all regulations, companies exposed to Dodd-Frank rules will be considered guilty until they can prove themselves innocent … continuously and consistently.

Ends --

By Patrick Reames, Managing Director.

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