EU AND US DERIVATIVES REGULATORY REGIME

EU AND US DERIVATIVES REGULATORY REGIME Regulators Principal regulators The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) ...
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EU AND US DERIVATIVES REGULATORY REGIME Regulators Principal regulators

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)

• Commodity Futures Trading Commission (“CFTC”) • Securities Exchange Commission (“SEC”) Additional regulators and authority • Department of Treasury bodies • Prudential regulators • Financial Stability Oversight Council (“FSOC”) Swap Dealers/Major Participants/Financial Counterparties Definitions of a swap dealer/major Security-based swap dealer and swap dealer (“swap dealer” or participants/ financial “SD”) counterparties • Holds itself out as a dealer in swaps, makes a market in swaps, regularly enters into swaps as an ordinary course of business for its own account, or engages in activity causing itself to be commonly known in the trade as a dealer/market-maker • the determination of whether a person is a swap dealer will consider all relevant facts and circumstances, and focus on the activities of a person that are usual and normal in the person's course of business and identifiable as a swap dealing business • making a market in swaps is described as routinely standing ready to enter into swaps at the request or demand of a counterparty • a person making a one-way market in swaps may be a market maker, and exchange-executed swaps are relevant in the determination • examples of activities that are part of "a regular business," and therefore indicative of swap dealing, are entering into swaps to satisfy the business or risk management needs of the counterparty, maintaining a separate profit and loss statement for swap activity, or allocating staff and resources to dealer-type activities • Exceptions: Subject to a de minimis exception and exception for swaps in connection with an insured depository institution’s origination of a loan

EU European Market Infrastructure Regulation (“EMIR”) • National regulators (“competent authorities”) • European Securities Market Authority (“ESMA”) • European Systematic Risk Board (“ESRB”)

Definitional distinction only exists between “Financial Counterparties” and “Non-Financial Counterparties”. As such, the requirements are ‘position’ based, as opposed to ‘product’ based (as with Dodd-Frank). • Financial Counterparties include (amongst others) investment firms, credit institutions, insurance and reinsurance undertakings, undertakings for collective investments in transferable securities and alternative investment funds (which can be located either inside or outside the EU) that are managed by alternative investment fund managers who are authorised or registered in accordance with the Alternative Investment Fund Managers Directive (AIFMD). • Non-Financial Counterparties are any parties that are not Financial Counterparties and are established in the European Union. For the purpose of EMIR’s provisions that have extraterritorial scope, entities which are domiciled outside of the EU (“third country entities”) might consider their classification under EMIR on this basis of whether they would be a Financial or Non-Financial Counterparty, ‘if’ they were domiciled in the EU.

Major security-based swap participant and major swap participant (“major participant” or “MSP”) • Person that maintains a “substantial position” in swaps in any of the major swap categories (excluding positions held for

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EU AND US DERIVATIVES REGULATORY REGIME

Registration Requirements

Reporting and Record Retention Requirements

Business Conduct Standards

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) “hedging or mitigating commercial risk”) • Person whose swaps create substantial counterparty exposure that could have serious adverse effects on U.S. financial stability • A financial entity that is highly leveraged relative to the amount of capital such entity holds and not subject to capital requirements

EU European Market Infrastructure Regulation (“EMIR”)

• Registration with either the CFTC and/or (eventually) the SEC depending on what products are traded: security-based swaps/swaps (collectively, “swaps”) • CFTC registration for SDs and MSPs occurred at the end of 2012; additional registrants trickling in since then • Registration effected through the National Futures Association • Ability to register as a limited purpose SD (with respect to certain products only) • Three types of reporting – real-time public reporting (Part 43), reporting of new transactions (Part 45) and reporting of historical transactions (Part 46) • Certain reporting requirements may be satisfied by executing on a SEF or CFTC-designated contract market (DCM), • Record retention requirements of trades (including preexecution and post-execution data) • Requirements to record complete transaction and position information; keep basic business records, minutes and audit documentation

• There is no specific registration requirement, although in order to provide investment services or activities as a regular occupation or business on a professional basis in relation to derivative contracts, a Financial Counterparty must be approved under the Markets in Financial Instruments Directive (“MiFID”).

External Business Conduct Standards • Duty to verify eligibility of counterparty’s ability to transact • Duty to disclose risks, conflicts of interest; provide daily marks of uncleared swaps • Duty of fair dealing and good faith communication, institutional suitability and market execution standards

• MiFID contains a number of business conduct standards, including acting in the best interests of clients, duties to provide best execution, manage conflicts of interest, take account of rules that provide certain protections for client money and assets, and consider the suitability (when giving investment advice

• Financial Counterparties and Non-Financial Counterparties, are obliged to report (to a trade repository or ESMA) details of any OTC derivatives contracts they have entered into. This includes novation, termination or modification of existing contracts. The reporting obligation is presently expected to commence in February 2014. • Third country entities are not required to report under EMIR. • No current public reporting regime under EMIR like Dodd-Frank; however the current MiFID review proposes pre- and post- trading transparency for certain OTC derivatives (note: pre-trading requirements are not proposed under Dodd-Frank)

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EU AND US DERIVATIVES REGULATORY REGIME The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) • Certain additional duties imposed on SDs acting as advisors or counterparties to Special Entities • “Special Entities” include federal agencies, state and political subdivisions, municipalities, employee benefit plans and government plans

Clearing

Internal Business Conduct Standards • Designation of Chief Compliance Officer • Risk management program • Trading Documentation, Portfolio Reconciliation and Compression • Requirement to clear swaps determined to be clearable by the CFTC • To date, CFTC has made one clearing determination, which requires many interest rate swaps and index credit default swaps to be cleared unless an applicable exemption applies

Capital and Margin Requirements

• Applicable to banks and non-banks • Margin requirements for cleared trades are driven by clearinghouses and FCMs • Margin for uncleared trades will be determined by the regulators • This month the Board of the International Organization of Securities Commissions (IOSCO) released a third paper regarding margin requirements for uncleared swaps • A final rulemaking by the CFTC could occur this year • May contain significant phase-in schedule

Segregation of Collateral and other

Uncleared Swaps

EU European Market Infrastructure Regulation (“EMIR”) or performing investment portfolio management regarding investment products) or appropriateness of transactions.

• Requirement for derivatives entered into by Financial Counterparties and Non-Financial Counterparties above the clearing threshold (as well as by certain applicable third country entities) to be cleared where they are of a class of derivative contracts determined to be eligible for clearing by ESMA, ESRB and competent authorities. • No clear carve out for pre-existing swaps. • In respect of uncleared trades, and except for intragroup transactions, Financial Counterparties must have risk management procedures in place, requiring the timely, accurate and appropriately segregated exchange of collateral in relation to all OTC derivatives entered into on or after 16 August 2012. Non-Financial Counterparties above the clearing threshold must also have such procedures in place, after they exceed the clearing threshold • Current proposals are for variation margin to be exchanged between all applicable counterparties. ESMA is considering the extent to which initial margin should be provided • Requirements shall not be finalised until ESMA publishes regulatory technical standards specifying the details relating to required collateral arrangements Uncleared Swaps

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Risk Mitigation Requirements

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) • Initial margin may be segregated upon election by end-user • Segregated initial margin must be held at a custodian that is independent of both the counterparty and the SD/MSP • Currently no limitation on the type of collateral that can be posted Cleared Swaps (see FCM/IB/CCP)

Futures Commission Merchants (“FCM”)/Introducing Brokers/Clearing Members • New conflict of interest policies and procedures • Designation of Chief Compliance Officer Segregation and Bankruptcy • CFTC has adopted a model for the segregation of collateral known as “legal segregation with operational commingling” (“LSOC”) • FCMs are required to segregate in their books and records cleared swaps and customer collateral from their own obligations and the obligations of non-customers and to treat customer collateral as belonging solely to the customer • Operationally an FCM may commingle all of the customer collateral deposited by all customers in one account Capital and Margin Requirements • Capital requirements are set by the regulators • Margin requirements for cleared swaps are driven by clearinghouses and their members End-Users/Non-Financial Counterparties Registration Requirements • None Reporting and Record Retention • No requirement to register Requirements • End-users will generally not have responsibility for reporting of transactions unless they are the only U.S. person to a transaction or they face another end-user in the transaction Business Conduct Standards

EU European Market Infrastructure Regulation (“EMIR”) • Margin may be segregated at counterparty election; currently not limited to initial margin • Mark-to-market valuations of outstanding derivatives contracts on a daily basis; electronic confirmation of contract terms; auditable processes for the reconciliation of portfolios and valuation of outstanding contracts; appropriately segregated exchange of collateral; and proportionate holding of (additional) capital; NB: some of these provisions apply to all counterparties but some do not apply to non-financial counterparties below the clearing threshold Cleared Swaps (see FCM/IB/CCP) • Covered by MiFID for Financial Counterparties • Clearing members must keep records of accounts allowing the client assets to be segregated from other clients. • Ability for clients of clearing members to require their collateral to be segregated from that of other clients within the CCP.

• Set by the CCPs in accordance with regulatory technical standards. • None • All Non-Financial Counterparties must report details of any derivative contracts they have concluded, modified or terminated to a trade repository, no later than the working day following such conclusion, modification

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EU AND US DERIVATIVES REGULATORY REGIME The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) • End-users are required to maintain full, complete and systematic records relating to their swaps Clearing

• Requirement to clear swaps determined to be subject to mandatory clearing by the CFTC, unless an exception applies • End-user exception requirements include (1) that the entity claiming the exception not be a “financial entity,” as defined, (2) that each swap hedge or mitigate commercial risk and (3) reporting requirements. • There is another exception to mandatory clearing, which applies to swaps between affiliates, but it is expected to be used mainly by non-end-users. • Swaps may also be voluntarily submitted for clearing

Segregation of Collateral

• May elect segregation of initial margin by SDs or MSPs for uncleared swaps • Margin for uncleared trades will be determined by the regulators • Clearinghouses and their members set margin requirements for cleared trades

Capital and Margin Requirements

EU European Market Infrastructure Regulation (“EMIR”) or termination. The reporting obligation is presently expected to commence in February 2014. • There is no end-user exception, although there is a clearing threshold concept. Non-Financial Counterparties are only obliged to clear their eligible derivative contracts, if their positions exceed certain relevant clearing thresholds (for purposes of threshold calculations, hedging contracts linked to commercial or treasury financing activities are exempt); once a threshold in relation to a particular asset class is exceeded, all contracts including those exempt for purposes of calculating the threshold are subject to clearing. • The thresholds are as follows: a) EUR 1 billion in gross notional value for OTC credit derivative contracts; b) EUR 1 billion in gross notional value for OTC equity derivative contracts; c) EUR 3 billion in gross notional value for OTC interest rate derivative contracts; d) EUR 3 billion in gross notional value for OTC foreign exchange derivative contracts; or e) EUR 3 billion in gross notional value for OTC commodity derivative contracts and other OTC derivative contracts not provided for under points (a) to (d). • May elect segregation of initial and variation margin for uncleared swaps • Margin requirements apply in respect of uncleared trades and are applicable to Financial Counterparties (and Non-Financial Counterparties above the clearing threshold). See Capital and Margin Requirements in relation to Financial Counterparties above. • Non-financial Counterparties below the clearing threshold have no obligations to post margins. • Capital requirements are only applicable to Financial Counterparties.

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EU AND US DERIVATIVES REGULATORY REGIME Retail Investors (non-ECP) Registration Requirements Designated Contract Market

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)

• None • Prohibition on OTC trading if not an “eligible contract participant” (“ECP”); exchange trading only Derivatives Clearing Organizations (“DCO”)/Central Clearing Counterparties (“CCP”) Registration/Authorization • CFTC and SEC registration and authorization requirements Segregation and Bankruptcy

• “Legal segregation with operational commingling” rule (“LSOC”) applies to DCOs and CCPs as well as FCMs (see FCM/IB/CCP above) • DCOs are required to segregate in their books and records cleared swaps and customer collateral from their own obligations and the obligations of non-customers and to treat customer collateral as belonging solely to the customer • Operationally a DCO may commingle all of the customer collateral deposited by all customers in one account

Core Principles/Conduct Standards

• Core principles relate to, among other things, participant and product eligibility; risk management; settlement procedures; treatment of funds; default rules and procedures; rule enforcement; system safeguards; reporting; recordkeeping; public information; information sharing; and antitrust considerations.

EU European Market Infrastructure Regulation (“EMIR”) • None • Not applicable • CCPs established in the EU must apply for authorization by competent authorities • CCPs must keep separate records and accounts that enable them to distinguish assets and positions held for one clearing member from the assets and positions held for another clearing member and from their own assets. • CCPs shall agree to keep separate records and accounts enabling clearing members to segregate in accounts with the CCP, the assets and positions of clearing members from its clients (“Omnibus Client Segregation”). • CCPs shall offer to keep separate records and accounts enabling clearing members to distinguish between accounts held for a client from those held for other clients (“Individual Client Segregation”). • CCPs shall publicly disclose the level of protection and the costs associated with the different levels of segregation they provide and the main legal implications of the respective levels. • CCPs shall have a right of use relating to the margins or default fund contributions collected via security financial collateral arrangement and the CCP shall publicly disclose the right of use. • Overriding duty to act fairly, honestly and professionally in the best interests of its clearing members and to effect sound risk management. • Establish appropriate admission, suspension and orderly exit criteria for clearing members. • Public disclosure of fees associated with services provided and any breaches by its members and the volume of cleared transactions for each class of instruments cleared by the CCP on an aggregated basis.

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EU AND US DERIVATIVES REGULATORY REGIME The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)

• • • • • •

Capital Requirements

• Set by the regulators

• • • •

Swap Data/Trade Repositories (“SDRs”) • Creation of such repositories to accommodate reporting requirements required by SDs • Governance, compliance and operational requirements Swap Execution Facilities (“SEFs”)/Organized Trading Facilities • SEFs are a new type of trading facility created by Dodd-Frank in which multiple participants have the ability to execute or trade swaps by accepting bids and offers • Swaps that the CFTC subjects to mandatory clearing must be executed on either a SEF or DCM unless no SEF or DCM makes the swap “available to trade” • The CFTC has rulemakings related to, among other things, core principles and other requirements for SEFs, and the process by which a SEF or DCM may make a swap available to trade Applicable to All Persons Extraterritorial Reach • CFTC has finalized guidance relating to extraterritorial matters • CFTC guidance widely considered somewhat vague or confusing with respect to certain key details • Depending on the CFTC substantive requirement and the parties

EU European Market Infrastructure Regulation (“EMIR”) Disclosure of risks associated with services provided. Accessible, transparent and fair rules for the prompt handling of complaints. CCPs shall maintain and operate arrangements to identify and manage any potential conflicts of interest. CCPs shall establish procedures to ensure the timely and orderly settlement of assets and positions. CCPs must have a board and senior management of sufficiently good repute and experience. CCPs must establish a Risk Management committee to advise the board of the CCP. Record keeping requirements. Set by the CCPs in accordance with regulatory technical standards. Permanent and available initial capital of at least €7.5m. Capital held shall be proportionate to risks from its activities.

• Creation of trade repositories to centrally collect and maintain records of OTC derivatives. • Governance, compliance and operational requirements. • No facilities specific to swaps. Once MiFID II is in place, swaps can be executed on regulated exchanges, multilateral trading facilities, organised trading facilities and on an OTC basis.

• Certain obligations under EMIR have extraterritorial scope. • Third country entities may have either clearing obligations or risk-mitigation obligations, provided: 1)

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Anti-manipulation Rules

Position Limits

Exchange Trading Requirements

FX Swaps

Swaps Push-Out Rule

Volcker Rule

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) to a particular transaction, the CFTC’s own rules may apply, or the rules of a non-U.S. jurisdiction • Guidance provides for “substituted compliance” in many cases, under which non-U.S. rules will apply if the CFTC deems those rules to be sufficiently comprehensive and comparable to the CFTC’s own rules • SEC has proposed, but not finalized, cross-border rules • Expands authority of the Commission to prohibit fraudulent and manipulative behavior • Special provision for manipulation by false reporting • New prohibition regarding false information • Position limits to be placed on swaps relating to many physical delivery contracts • Original CFTC rule was vacated in litigation and remanded to CFTC; no rule is yet finalized • No similar US legislation has been proposed.

• Treasury elected to exempt vanilla FX swaps and forwards from the definition of “swap” for certain purposes, including dealer registration, mandatory clearing and trade execution, and margin • However, business conduct standards, including documentation requirements, still apply to vanilla FX swaps and forwards • Insured depositary institutions will not receive federal assistance if they are engaged in swap trading activities other than: (1) hedging/risk mitigation strategies directly related to it’s activities; (2) CDS if cleared and (3) swaps related to certain rates and reference assets, exchange rates, government and investment grade corporate debt • Effect is to move swap activities related to equities, commodities and non-investment grade debt to another entity • A 24-month transition period applies, measured from no earlier than July 16, 2013 • Regulations proposed but not finalized

EU European Market Infrastructure Regulation (“EMIR”) they would have such obligations if they were domiciled in the EU; and 2) the relevant OTC derivatives contracts have a direct, substantial and foreseeable effect within the EU (or such obligation is necessary or appropriate to protect the evasion of any provision of EMIR). • No similar EU legislation has been proposed.

• The current MiFID review contemplates setting position limits; competent authorities will look to EU set limits • The current MiFID review proposes to give ESMA oversight over determinations on whether cleared products need to be traded on Multilateral Trading Facilities (“MTF”) or “organized trading facilities” (“OTF”) • No similar provision

• No similar provision as yet.

• No similar provision

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EU AND US DERIVATIVES REGULATORY REGIME The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) • Subject to certain exceptions, banking entities and systemically important non-banking entities are prohibited from engaging in proprietary trading other than for: (1) purchases and sales of US Treasuries, GNMA, FNMA, FHLMC, FAMC or any agency of the state (2) underwriting or market-making related activities to the extent designed not to exceed the reasonably expected near terms demands of clients (3) risk mitigating hedging activities (4) purchases, sales or dispositions of securities on behalf of customers (5) trading outside the US (6) anything else deemed appropriate by regulators

EU European Market Infrastructure Regulation (“EMIR”)

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