Alberto Corvo, of eClerx Services, explains how firms can prepare legal and data management processes support the implementation of the ISDA Dodd-Frank Protocol and comply with new regulatory rules covering business conduct standards and reporting.
One of the many deadlines that have been formalized, for the time being, as a result of the Commodity Futures Trading Commission (CFTC) publishing the definition of a swap in the Federal Register is compliance to the external business conduct rules by mid October 2012. While at every institution, the rules will likely require legal assistance for interpretation, International Swaps and Derivatives Association (ISDA) has compiled a very useful set of resources on their website explaining the finalized CFTC rules, their impact, and the ISDA Dodd-Frank Protocol. The ISDA Dodd- Frank Protocol consists of a suite of documents that allows the amendment of all agreements governing swaps between a swap dealer and counterparty to accommodate seven finalized CFTC rules covering Business Conduct Standards and Reporting. Unlike other protocols, each party that opts-in to the protocol also needs to complete questionnaires and deliver them bi-laterally to each of their counterparties.
These CFTC rules have been in discussion for quite some time, but now that a deadline has been created, the importance of complying with the new rules and executing the mechanics of amending corresponding legal agreements is quite complex. Fortunately, to address the latter requirement, ISDA is making available an electronic matching platform called “ISDA Amend,” which provides an electronic interface for parties who have opted in to the protocol, to confidentially, and bi-laterally exchange information. This novel approach to accommodate a novel protocol will drastically cut-down on the administrative documentation effort to formalize the new CFTC rules within trading agreements.
However, despite the new platform, there will still be a considerable amount of effort required by sell-side institutions to put the protocol into play. These efforts broadly are composed of:
• Client data preparation which includes the de-duplication of client entities, establishing US person status, sourcing client contact details, and mapping counterparty static data to ISDA agreements and ideally Legal Entity Identifiers (LEIs).
• Protocol facilitation and exception management which includes proactive customer outreach, responses to frequently asked questions, disciplined chasing until protocol adherence or known objection, and closing out objections through the negotiation and agreement of side-letters.
• Data warehousing and other support composed of storing additional information obtained from counterparties, the performance of obligations contained within the new rules, and ensuring that internal cross-department training is performed to educate all stakeholder groups of the day to day impact of the new regulations and corresponding internal policies to enforce them.
As with many large scale initiatives, those that invest in disciplined planning efforts, especially given the short timeframe, will yield disproportionate benefits. These benefits include a competitive advantage against other swap dealers by staying ahead of the curve. Inevitably, there will be a flurry of activity as the compliance date comes closer, and moving through the steps to comply with the protocol early in the cycle will allow those swap dealers to be seen as thought leaders, and potentially capture more market share, depending on the level of preparedness of their peers. Other benefits will include better control of the current protocol via more stable execution as a result of a longer ‘bedding-down’ period and potentially lower long terms costs due to the avoidance of ‘spike’ resourcing. Finally, investing now will yield a series of longer term benefits as project plans can be leveraged for similar future protocols and many of the milestones will overlap with existing and future regulatory activities, for example Know Your Customer (KYC) required by The Patriot Act, client data cleansing, required by The Foreign Account Tax Compliance Act (FATCA), etc.
But of course, the key question is how can this entire protocol be effectively and efficiently executed?
Given the time pressure, one approach is to modularize the project and tap a specialist set of resources to carry each out each logical grouping of activities. This way, the project support team can be tiered based on the complexity of each set of tasks and team sizes can be scaled as effort requirements become clearer. It’s important to take a holistic view, as each initiative will require resources across multiple departments – legal for document negotiation, IT for data warehouse creation and small scale automation, and operations / on-boarding for client data processing, and compliance for setting policies. It’s equally important to take a broad view when lining-up resources for the project – while leveraging existing internal resources should obviously be considered, external software and services providers should also be evaluated, given the project nature of this exercise and the time pressure for ramping up support. Temporary and third party offshore resource pools provide financial institutions the added benefit of low labor costs and also “variabilizing” such costs by adjusting the team size as effort utilization varies.
Furthermore a partner should also be able to assist with the following:
• Mapping out input data elements, how they are processed, where exceptions will be generated, and the shape of final deliverables, facilitating the modular execution approach mentioned above.
• The identification of critical-to-quality metrics and the production of a flexible reporting suite so financial institutions can forecast resource requirements and understand key exception themes. As a concrete example, based on the counterparties objecting to the protocol, an “objection library” would prove very useful for legal, as it will allow them to shift effort to the largest objection types and perhaps develop customized solutions to issues such as drafting standard side letter agreements.
• Assisting with the warehousing of additional KYC information by potentially developing a stand-alone, searchable repository and transforming, validating, and loading data.
• Institutionalizing the new regulations by creating training material, including traditional documentation, in addition to Computer Based Learning modules which can be integrated within in-house learning management systems.
Important considerations when selecting partners for this exercise include specialist ability, breadth of coverage across the project tasks required, operational excellence, information security safeguards, and agility.
In conclusion, while implementing the ISDA Dodd-Frank Protocol may seem like a daunting task, disciplined planning, while modularizing similar functions, and sourcing the optimal balance of specialist skill-sets internally and externally will be key to smooth and cost efficient execution.
