Category Archives: Derivatives

U.S. Uncleared Swap Margin, Capital, and Segregation Rules

Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP, and a former commissioner at the U.S. Securities and Exchange Commission. The following post is based on a Davis Polk visual memorandum; the complete publication, including charts, is available here.

U.S. prudential regulators (the OCC, Federal Reserve, FDIC, FCA and FHFA) and the CFTC have finalized uncleared swap margin, capital and segregation requirements (the “PR rules,” and “CFTC rules,” respectively, and the “final rules,” collectively).* The PR rules apply to swap entities that are prudentially regulated by a U.S. prudential regulator (“PR CSEs”). The CFTC rules apply to swap entities that are regulated by the CFTC and that are not prudentially regulated (“CFTC CSEs”). In this memorandum, “covered swap entities” refers to PR CSEs and CFTC CSEs, together.

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Proposed Rule on Registered Funds’ Use of Derivatives

David C. Sullivan is partner in the Investment Management practice at Ropes & Gray LLP. This post is based on a Ropes & Gray publication by Mr. Sullivan, Tim Diggins, George Raine and Sarah Clinton.

On December 11, 2015, the SEC issued its long-anticipated release (the “Release”) proposing Rule 18f-4 (“the “Proposed Rule”) under the 1940 Act regarding the use of derivatives and certain related instruments by registered investment companies (collectively, “funds”). The stated objective of the Release is to “address the investor protection purposes and concerns underlying section 18 [of the 1940 Act] and to provide an updated and more comprehensive approach to the regulation of funds’ use of derivatives” in light of the increased participation by funds in today’s large and complex derivatives markets.

We provide an executive summary of the Proposed Rule and other aspects of the Release below and, in the Appendix of the complete publication, we discuss the Proposed Rule in more detail.

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Corporate Governance and Blockchains

David Yermack is Professor of Finance at the NYU Stern School of Business. This post is based on a recent article authored by Professor Yermack.

In the paper, Corporate Governance and Blockchains, which was recently made publicly available on SSRN, I explore the corporate governance implications of blockchain database technology. Blockchains have captured the attention of the financial world in 2015, and they offer a new way of creating, exchanging, and tracking the ownership of financial assets on a peer-to-peer basis. Major stock exchanges are exploring the use of blockchains to register equity issued by corporations. Blockchains can also hold debt securities and financial derivatives, which can be executed autonomously as “smart contracts.” These innovations have the potential to change corporate governance as much as any event since the 1933 and 1934 securities acts in the United States.

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CFTC’s Proposed Rules on Cybersecurity

Dan Ryan is Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Mr. Ryan, Sean Joyce, Joseph Nocera, Jeff Lavine, Didier Lavion, and Armen Meyer.

Last week, the Commodity Futures Trading Commission (CFTC) proposed cybersecurity regulations for electronic trading platforms, clearing organizations, and data repositories. Most importantly, the proposal calls for five types of systems testing, the most impactful of which is the requirement that organizations test key controls (e.g., access to sensitive data or procedures that control changes to critical systems).

Guidance from other regulators thus far has come in the form of examination guidelines or self-assessment tools rather than regulations. [1] The CFTC’s proposal would be the first cybersecurity regulation, and some other regulators are likely to follow suit. [2]

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Chair White Statement on Use of Derivatives

Mary Jo White is Chair of the U.S. Securities and Exchange Commission. The following post is based on Chair White’s remarks at a recent open meeting of the SEC, available here. The views expressed in this post are those of Chair White and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The Commission will consider two separate recommendations from the staff today [December 11, 2015]. First, we will consider and vote on a recommendation from the staff of the Division of Investment Management to propose an updated and more comprehensive approach to the use of derivatives by mutual funds and exchange-traded funds, closed-end funds, and business development companies.

Second, we will consider and vote on a recommendation from the staff of the Division of Corporation Finance to propose rules to require disclosure of certain payments made to governments by resource extraction issuers, as mandated by the Dodd-Frank Act.

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Protecting Investors through Proactive Regulation of Derivatives

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent public statement at an open meeting of the SEC; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Today [December 11, 2015], the Commission considers new rules that are designed to protect investors by addressing the use of derivatives by registered investment companies. As demonstrated by the 2008 financial crisis, and the economic turmoil that followed, years of regulatory complacency and deregulation enabled an unregulated derivatives marketplace to cause significant losses to investors. In response to that crisis, in 2010, Congress passed the Dodd-Frank Act to address the causes of the financial crisis, and specifically included provisions in Title VII of the Act mandating the establishment of a regulatory framework for addressing broad categories of derivatives. This process is still ongoing.

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Dissenting Statement on Use of Derivatives

Michael S. Piwowar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Piwowar’s recent remarks at a recent open meeting of the SEC. The complete publication, including footnotes, is available here. The views expressed in the post are those of Commissioner Piwowar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Today [December 11, 2015], we are considering a proposed new exemptive rule that addresses the use of derivatives and financial commitment transactions by registered investment companies and business development companies (collectively, “funds”). This proposal is the third in a series of initiatives aimed at ensuring that the Commission’s regulatory program fully addresses the increasingly complex portfolio composition and operations of the asset management industry.

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Insider Trading and Tender Offers

Christopher E. Austin and Victor Lewkow are partners focusing on public and private merger and acquisition transactions at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum.

Valeant’s hostile bid for Allergan was one of 2014’s most discussed takeover battles. The situation, which ultimately resulted in the acquisition of Allergan by Actavis plc, included a novel structure that involved a “partnership” between Valeant and the investment fund Pershing Square. In particular, a Pershing Square-controlled entity having a small minority interest owned by Valeant, acquired shares and options to acquire shares constituting more than nine percent of Allergan’s common stock. Such purchases were made by Pershing Square with Valeant’s consent and with full knowledge of Valeant’s intentions to announce a proposal to acquire Allergan. Pershing Square and Valeant then filed a Schedule 13D and Pershing Square then supported Valeant’s proposed acquisition. Ultimately Pershing Square made a very substantial profit on its investment when Allergan was sold to Actavis.

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Derivatives and Uncleared Margins

Dan Ryan is Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Mr. Ryan, Mike Alix, Adam Gilbert, Armen Meyer, and Christopher Scarpati.

Over the past two weeks, the US banking regulators released their much anticipated final margin requirements for the uncleared portion of the derivatives market. [1] This portion amounts to over $250 trillion of the global $630 trillion outstanding and has up to now been operating in “business as usual” mode, [2] while other derivatives have been pushed into clearing. The final rule’s release completes a long process since it was proposed in 2011 and re-proposed in 2014. [3]

The good news for the industry is that the final rule is generally aligned with international standards [4] and similar requirements proposed in major foreign jurisdictions. Most notably, the final rule increases the threshold of swap activity that would bring a financial end user (e.g., hedge fund) within the rule’s scope from $3 billion to $8 billion. This change, which aligns the rule with European and Japanese proposals, eases the compliance burden of smaller, less-risky market participants.

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13(d) Reporting Inadequacies in an Era of Speed and Innovation

David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. This post is based on a Wachtell Lipton publication by Mr. Katz and Laura A. McIntosh. The complete publication, including footnotes, is available here. Related research from the Program on Corporate Governance includes The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here); and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.

The Securities and Exchange Commission and other market regulators confront a challenging issue: How to effectively monitor and regulate activity in an environment that is both fast-moving and highly complex? The principles and architecture of the Securities Exchange Act of 1934 were created for a much simpler financial world—an analog world—and they struggle to describe and contain the digital world of today. The lightning speed of information flow and trading, the constant innovations in financial products, and the increasing sophistication of active market participants each pose enormous challenges for the SEC; together, even more so. The ongoing controversy over Section 13(d) reporting exemplifies the many challenges facing the SEC in this regard.

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