A Brief Overview of Dodd-Frank
The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which came into effect on July 21, 2010 sets forth a series of regulations intended to regulate swap dealers and to protect customers. Prior to this legislation, swaps were not thoroughly regulated, an oversight which some allege led to the 2008 financial crisis.
Under Dodd-Frank, the CFTC is permitted to regulate swap dealers by requiring them to meet detailed reporting obligations, trade derivatives on regulated exchanges, and to lower the risk to customers through the use of central clearinghouses. One part of the Dodd-Frank Act that came into effect in 2012 was the Volcker Rule. This Rule further protects customers by preventing banks from investing in funds for their own profit and compelling them to determine which funds are for customers.
As a means of efficiently implementing the Dodd- Frank documentation requirements, ISDA released Protocols I and II. Protocol I, which came into effect in August 2012, focused on applying a section of the CFTC Final Rules known as the External Business Conduct Rule (“EBC”). Under the EBC, swap dealers that transact swaps with counterparties defined as “US Persons” are subject to several different fiduciary duties and regulations. The intention of Protocol I was not only to make standard changes to different agreement types, but also to collect specific information from each counterparty, in compliance with the CFTC Final Rules. Parties were able to adhere to Protocol I by submitting to ISDA a signed “Adherence Letter” along with a $500 fee. They were then required to provide detailed information in the form of a Questionnaire, in order for counterparties to determine whether an entity is suitable to evaluate a transaction. In addition, the Questionnaire provided the option for safe harbors, to protect either party in the event that an entity is not capable of evaluating a transaction. The relevant schedules were then incorporated into the specific agreements based on the type of entity identified through the Questionnaire.
Following the August 2012 Protocol, ISDA subsequently released Protocol II, which provided the means for parties to comply with the Swap Trading Relationship Documentation Rule (“STRD Rule”). Where Protocol I focused on collecting information about the identification of each entity, Protocol II covered the documentation for the swap transaction, portfolio reconciliation, and the end-user exception. In order to adhere to this Protocol, parties not only had to submit an Adherence Letter and $500 fee, but also had to provide information regarding the trading relationship, the terms of reconciliation and information to determine whether a party was exempt from the clearing requirements under the end user exception.