Financial regulation: what you are up against and what is in it for you

26 November 2014

When it comes to negotiating derivatives and other financial deals it pays to know in advance what is in store for you – and how to deal with, and even benefit from it

If you are reading this, chances are that your business enters into derivatives with some frequency, likely to hedge commercial risk stemming from your business’s regular activity. It is also likely for a significant number of your counterparties to be US or European financial entities.

It is precisely in the US and in the European Union where the most dramatic regulatory changes has been taking place since 2010. As a result of the crisis that began in 2008, the G20 countries vowed to tighten financial regulation in order to avoid any further crashes by introducing a sea change in the way financial transactions, especially derivatives, are conducted. Those changes are meant to correct what was perceived as deep structural flaws in the financial markets, preserve market integrity and protect financial entities’ clients.

If you negotiate with a US or European dealing entity, you are almost certain to find in the master agreement or its miscellaneous documentation language alluding to things such as FATCA, Dodd-Frank, EMIR and MiFID under each of which you are required to make a number of representations and agree a number of mechanics. Those regulations are mandatory for those dealers, so it is unlikely that they will agree to remove stipulations pertaining to them. On the other hand, save for FATCA, those regulations are meant to protect dealer’s clients such as perhaps your business (if it is not a derivatives dealer itself), so it pays to have a good working knowledge of those regulations and how they are supposed to benefit you.

Being an end user under Dodd-Frank, an NFC- under EMIR or a retail or professional client under MiFID will each place you in a category that will afford your business a number of rights and benefits. Knowing those rights and benefits will put you in a better bargaining position when negotiating terms and conditions with a derivatives dealer. You will also know what to expect every step of the way and plan your hedging strategy more wisely.

You also need to bear in mind Basel III, which has an impact on capital consumption. When the collateralisation regulations under Dodd-Frank and EMIR are finally effective (in the near future), hefty collateral requirements and capital consumption will apply to certain types of trades and counterparties, likely rendering such transactions uneconomic in a number of circumstances. You need to know this too, anticipate it and, if it does impact your business, plan accordingly in order to avoid pitfalls.

Depending on your circumstances, you may need to gain access to clearing through a US derivatives clearing organization or a European central counterparty, as certain transactions would, in some circumstances, be subject to mandatory clearing. Some of those would in turn be subject to mandatory trading on a trading venue as well, in which case you would need to gain access to a SEF (in the US), or an MTF (in the EU) as well. Even if not mandatory, it might still make sense for your business to, clear its transactions, as in some scenarios as doing so might be cheaper than entering into the same transaction on a bilateral basis.

So the bottom line is that your business needs to be regulation-aware for a wise hedging strategy and to deal with international financial entities in general. Yet Dodd-Frank, EMIR and the rest are awfully complex regulations to master, and there is a lot of them. As you read this, a number of other countries such as Australia, Canada, Switzerland, Japan, Singapore and Hong Kong are developing their own regulation, along similar lines, which will likely further add to the complexity.

Ironically, this multi-jurisdictional regulatory avalanche, that was intended to benefit end users and smaller players, is of such magnitude that becoming properly conversant with it is beyond the possibilities of most in-house legal departments. Several lawyers would normally be required to stay on top of this ever-changing landscape, on a full-time basis.

Here is where we can help: Our international team of senior lawyers is specialised in business and financial markets. Let us put our thorough knowledge in US and European financial regulation and our valuable skill set at the service of your business.

Contact us for a confidential, no-obligation discussion.