The consequences of the 2016 presidential election are likely to have a profound impact on over-the-counter derivatives markets. In particular, the expected changes to the Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)—if not an outright repeal—could significantly impact a wide range of industries and customers globally. Title VII of Dodd-Frank was intended to ensure transparency and accountability to swaps markets. Over the past six and a half years, all market participants, including end-users, swap dealers, and major swap participants, spent billions of dollars implementing the Dodd-Frank statutory requirements, as detailed and enforced by the Commodity Futures Trading Commission (“CFTC”). Some of the Dodd-Frank requirements, such as mandatory margin implementation, position limits, cross-border swap application, and other rules are yet to be finalized.
One of the many major flaws of Dodd-Frank is the failure to exempt from its scope a large number of commercial activities that had nothing to do with the financial crisis of 2008-2009 and that already had a robust risk management history and infrastructure. One such commercial activity is the production and transport of energy commodities. If anything, the financial crisis of 2008-2009 demonstrated the energy industry’s ability to safely and calmly navigate the worst financial landscape. However, the energy industry, among many other industries, was forced to implement numerous Dodd-Frank regulation and to spend enormous sums of money to comply with many regulatory requirements that were misplaced and often overreaching. For example, when an energy company needs to borrow money to build its asset – a pipeline, an electric generation facility, or a crude oil storage tank—it often needs to lock-in a favorable interest rate for its financing. Then, the energy company enters into a plan vanilla fix-for-float swap agreement with an investment bank, i.e., a swap dealer. However, before the swap can be executed, the swap dealer usually sends over a long list of documentation requirements, as it is required to do by Dodd-Frank (or its European equivalent—“EMIR”), to the energy company, including a board resolution authorizing the exemption from swap clearing, a set of policies and procedures “reasonably drafted” to ensure that the energy company’s employees are sufficiently familiar with swaps, various ISDA protocols, margin rule representation letter, EMIR representation letter, and the list of “corporate events” and “life cycle” events the energy company, as an “end-user” under Dodd-Frank must communicate to the swap dealer in order for swap dealer to comply with its reporting requirements.
The nature of Dodd-Frank compliance requirements is very burdensome for most commercial market participants such as energy and agricultural commodities producers, transporters, and marketers, small and medium size banks, insurers, dealers and brokers, because most of them only use swaps occasionally to hedge their commercial operations and, consequently, do not have a robust risk management structure. End-users of swaps do not represent a systemic risk to the U.S. financial system, and the enormous amounts of resources spent on Dodd-Frank implementation only increases the financial burden of the commercial end-users’ customers as those costs are passed down the market chain. However, it does not appear that the CFTC differentiates between those market participants that could jeopardize the global financial system on one hand, and those commercial market participants that only use occasional swaps to manage price risk of their commercial enterprise on the other. In the rush to expand the jurisdiction and assume oversight of all commodities and derivatives, the CFTC appears to have overlooked the need to propose a measured and systemic approach toward a reasonable regulation. The best example of this rush to regulate was the re-labelling of dozens of swap products as futures. The CFTC renamed many swaps and began calling them futures, obliging market participants to trade those products on an organized exchange (and pay exchange fees) and to clear those products on the exchange (and pay clearing fees). While this name change may have been the easiest way to force market participants to trade on organized exchanges, the market participants were left with a complex and expensive task of restructuring their trading, hedging, credit and collateral processes in order to minimize the operational and financial impact of the short-sighted rulemaking. Many natural gas companies are still baffled by the CFTC’s decision that certain natural gas transport contracts could be swaps. The fact that the principal regulator of all commodities markets would label a service contract (natural gas transport) that can only be settled by physical flow of natural gas and called it a swap only demonstrates a lack of basic understanding of energy business. It begs the question, if a regulator does not have a basic understanding of the business it regulates, should such a regulator even continue regulating that business?
As the new U.S. administration forms its strategic vision for financial regulation, many market participants are anxiously awaiting to hear what will become of Dodd-Frank. While a wholesale repeal of the statute seems unlikely because it would create a regulatory vacuum and operational uncertainty, it is clear that many provisions of the statute are unreasonably burdensome. The most likely approach to rolling back Dodd-Frank would be to start eliminating those regulations that burden commercial market participants, especially those that only use swaps to manage their price risk exposure. Also, the regulation of liquidity providers such as dealers, investment banks, and brokers should not be so cost-prohibitive to force such liquidity providers to withdraw from the markets and, thereby, make it more difficult for commercial market participants to find a readily available hedging providers. Any path to rolling back Dodd-Frank is going to take a while because the devil will be in details. For example, the pending final rules on position limits and mandatory margin requirements, just to name two, are much better left to the underlying trading exchanges to manage because the exchanges have the historical data and technical resources to properly monitor and manage them. A margin requirement for bilateral, noncleared, swaps should be left to the counterparties to manage. Most of those bilateral swaps already include some kind of credit support document with margin thresholds. However, each market participant’s creditworthiness should be considered on a case-by-case basis and the best way to do that is at the time of a transaction, in the context of such a transaction and not by a Federal regulator. If the energy market participants had the necessary risk management and business acumen to safely navigate the financial crisis of 2008-2009, they can certainly continue to do so now without the need for the CFTC to hold their hand.
Since some Dodd-Frank final rules are still being finalized, six and a half years after the statute was enacted, any rolling back of the statute is also likely to take several years. What is important during this process is to ensure legal certainty and enforceability of swap and commodity transactions. Also, while it is uncertain where will Dodd-Frank end up, it may be helpful to remind ourselves how Dodd-Frank came about. The primary reason for creating Dodd-Frank was the notion that financial products such as credit default swaps created financial crisis because they were not regulated. The truth was much more simple but, politically uncomfortable–the financial crisis of 2008-2009 was created because some market participants using credit default swaps, mortgage backed securities, and other financial instruments acted irresponsibly, disregarded the most basic risk management principles and common sense. There were plenty of state and Federal statute on the books at the time to punish anyone who engaged in fraud, deception, market manipulation, and similar conduct. However, that would have created some uncomfortable choices for many regulators, prosecutors, and lawmakers. A more convenient approach was to declare that the swaps and other financial products went out of control and caused the financial crisis because they were not regulated. Therefore, a major statute with global impact was enacted, in a large part, based on a false premise. Let’s hope that its replacement will be based in reality and truth.
In recent years, participants in over-the-counter (“OTC”) derivatives markets have experienced an unprecedented regulatory burden. Because of Dodd-Frank, EMIR and similar regulations, the documentation for OTC derivatives is becoming increasingly complex and risky. Many companies are uncertain about their ability to hedge due to regulatory and financial risk associated with derivatives documentation. In order to facilitate an in-depth analysis of the OTC documentation drafting, analysis, and review, I will be conducting a two-day ISDA® seminar on April 5-6, 2017, in Omaha, NE
This seminar is intended to help attendees better understand the key provisions of the ISDA® Master Agreement, Credit Support Annex and various Schedules. In addition, attendees will learn the most relevant and recent regulatory developments regarding mandatory margin requirements, position limits, collateral management, and reporting requirements.
Some of the topics to be covered during this seminar will be:
- Architecture of ISDA® Documentation
- 1992 and 2002 Master Agreements
- 1994 Credit Support Annex
- Schedules to the master agreement and credit support annex, natural gas and power annex, crude oil annex, long form confirmation.
- Various confirmation provisions for interest rate, credit default, and FX swaps.
- Comprehensive overview of events of defaults, remedies, cross-affiliate and cross-products netting and setoff.
- Bankruptcy and liquidation considerations.
- Special considerations regarding swap reporting and recordkeeping under Dodd-Frank.
- ISDA® August 2012 and March 2013 Dodd-Frank Protocols.
- EMIR provisions applicabe to the U.S. market participants.
For more information about this seminar please contact Kolobara Law Firm by email at firstname.lastname@example.org or by phone at 402-881-3987.
Watching the events and the court case surrounding the Standing Rock Sioux Tribe, I appreciate that people are paying attention to any negative environmental impact an oil pipeline may have. At the same time, I cringe at the coverage and the absence of important factual information related to the pipeline’s legal permitting process. When I hear celebrities on the news claim the Dakota Access Pipeline is going through the heart of the Standing Rock Sioux Tribe’s land, I expect the reporters to correct them. The media should tell us that the pipeline follows existing utility easements (including the existing gas pipeline) and runs within half a mile of the tribal land, but does not cross it. No one wants any water to be in danger of contamination or sacred grounds to be destroyed. Because of the pipeline’s location near the Tribe’s land, and a planned route under a lake (again, following the same route as other pipelines, but here, going deeper and with double walls for extra protection), special attention is warranted. And a Federal Court, in response to an injunction filed by the Standing Rock Sioux Tribe, issued a painstakingly thoughtful, 58-page opinion that demonstrated it was fully “aware of the indignities visited upon the Tribe over the last centuries,” and “scrutinize[d] the permitting process with particular care.” See, Memorandum Opinion issued by the Honorable James E. Boasberg, U.S. Dist. Ct. Judge for the District of Columbia, in Standing Rock Sioux Tribe v. U.S. Army Corps of Engineers, Civil Action No. 16-1534, dated September 9, 2016, at p. 58.
The Standing Rock Sioux Tribe sued the United States Army Corps of Engineers to block the operation of the Corps permit process for the Dakota Access Pipeline (DAPL). Thereafter, the Tribe filed a motion for preliminary injunction alleging that the Corps flouted its duty to engage in trial consultations under the National Historic Preservation Act (NHPA) and that irreparable harm would ensue. In its ruling, the Court concluded that the Corps likely complied with the NHPA and the Tribe had not shown it would suffer injury that would be prevented by any injunction the Court could issue. See Memorandum Opinion at p.1-2.
To be clear, the Tribe did not file an action against the pipeline, nor did it seek an injunction against the Corps to halt the permitting process and protect itself from any potential environmental harms. Even though the media’s spotlight on this case is on water, the Tribe has not shown that the pipeline work is likely to cause damage. See Memorandum Opinion at p. 56. In fact, the area around the pipeline’s route has been subject to previous surveying for other utility projects. The pipeline “will run parallel, at a distance of 22 to 300 feet, to an already-existing natural gas pipeline under the lake. Dakota Access will also use the less-invasive HDD [Horizontal Directional Drilling] method to run the pipeline, which will require less disturbance to the land around the drilling and bury the pipeline at a depth that is unlikely to damage cultural resources.” Memorandum Opinion at p. 57 [citations omitted].
With respect to the Tribe’s claim that they had not been sufficiently consulted during the permitting process, the Court outlined the extensive efforts of the Corps—with little success—to consult with the Tribe beginning in September, 2014. Memorandum Opinion at p. 16. In addition to numerous attempts to schedule meetings, the record reflects many letters went unanswered despite extensions in the deadlines to respond, and meetings that were scheduled but later cancelled by the Tribe. See Memorandum Opinion at pp. 16-21. Although there appears to have been some sporadic meetings in 2015, the facts of the case demonstrate ongoing, often ignored, efforts to meet with representatives from the Tribe. Throughout this time, the Corps also invited the Tribe to a general tribal meeting in Sioux Falls set for December, 2015. While five other tribes attended, Standing Rock did not. Memorandum Opinion at pp. 24-25. Meetings did occur in earnest in 2016, with no fewer than seven between the Tribe and the Corps between January and May. In one significant meeting, the Tribe’s archaeologist met with the Corps to express specific concerns about tribal burial sites, and in response, the Corps verified the information and successfully instructed Dakota Access to move the pipeline to avoid them. Memorandum Opinion at p. 28. This fact seemed to carry particular weight with the Court, because it demonstrated the willingness to work with the Tribe and Dakota Access Pipeline’s ready acceptance to re-route where the Tribe raised specific concerns.
In fact, the Court’s extensive opinion outlines the early efforts by Dakota Access to plot its route based on past cultural surveys and then extensive, new surveys to identify potential cultural resources: “[b]y the time the company finally settled on a construction path, then, the pipeline route had been modified 140 times in North Dakota alone to avoid potential cultural resources.” Memorandum Opinion at pp. 13-14. Additionally, the records reflect that where other tribes raised concerns over the pipeline route, Dakota access responded. For instance, when a site was declared eligible for listing on the National Registry that had not previously been identified, Dakota access agreed to bury the pipeline 111 feet below the site to avoid disturbing it. Memorandum Opinion at p. 29. According to the Court, “Standing Rock took a different tack. The Tribe declined to participate in the surveys because of their limited scope. Instead, it urged the Corps to redefine the area of potential effect to include the entire pipeline and asserted that it would send no experts to help identify cultural resources until this occurred.” Memorandum Opinion at p. 29 [citations omitted].
That is why, in response to the Tribe’s claim that the Corps failed to offer it a reasonable opportunity to participate in the Section 106 process (the portion of the NHPA that requires a federal agency to consider the effects of its undertakings on property of historical significance, including property of cultural or religious significance to tribes), the Court said that the factual record of the case told a different story. Summarizing the events, the Court explained that the “Tribe largely refused to engage in consultations. It chose instead to hold out for more—namely, the chance to conduct its own cultural surveys over the entire length of the pipeline.” Memorandum Opinion at p. 48. The Corps contended, and the Court agreed, that it did not have jurisdiction over the entire pipeline, but only discrete areas involving certain waterways.
Overall, the impression left by the Tribe’s legal action appeared to be less about a desire to re-route the pipeline, but instead its intent to stop, and probably remove, the entire pipeline. The Court hinted at this in its opinion, and even pointedly noted that the “relief sought cannot stop the construction of DAPL on private lands, which are not subject to any federal law,” and which comprise of 99% of the pipeline’s route. Memorandum Opinion at p. 51, and at p. 2. It is worth noting, again, that the Court was not without sympathy: “[t]he tragic history of the Great Sioux Nation’s repeated dispossessions at the hands of a hungry and expanding early America is well known. The threat that new injury will compound old necessarily compels great caution and respect from this Court in considering the Tribe’s plea for intervention.” Memorandum Opinion at pp. 50-51.
The Court’s tedious review of the record and careful consideration of the law honored its promised diligence. Despite its heightened scrutiny of the motion before it, the Court ultimately found in that the Corps complied with its permitting obligations, and the Tribe had not shown it would suffer irreparable harm that could be prevented by any injunction the Court could issue.
On the same day the Court issued its ruling that the Corps did everything right, President Obama’s administration (through the Departments of Justice, Army, and Interior) issued a statement that they wanted the pipeline to halt anyway, to see if the Corps needed to reconsider any of its previous decisions regarding the environmental impact of the pipeline. I found this to be a surprising development—on the day the Corps won, it issued a statement that it would nevertheless re-evaluate its permitting, and asked Dakota Access to voluntarily halt construction. By all appearances, it would seem someone or some department above the Corps wanted to deflect the negative publicity, even when the Court ruled the Corps acted properly in granting the pipeline permits.
Then, amidst inaccurate reporting about the pipeline “going through the heart of” the Tribe’s land or through sacred land, the Corps denied the final easement in the pipeline’s construction after initially saying it should be granted. The chilling result is that companies building infrastructure can be faced with so much uncertainty. It is difficult concept to swallow that energy companies should be faced with a moving target—this pipeline is over 90% built—and only 3% of the entire route required any Federal approval.
I do not ignore the important social issues at stake. For instance, maybe the current framework is flawed for engaging a tribe and ensuring meaningful tribal input. If so, we should demand new legislation and ask Congress to change that framework. Nevertheless, even if the current framework is flawed, the facts of the case show that the Corps documented dozens of attempts it made to consult with the Standing Rock Sioux from the fall of 2014 through the spring of 2016 on the permitted pipeline activities, including at least three site visits to the Lake Oahe crossing. See Memorandum Opinion at pp. 14-33. I would encourage anyone who is skeptical of the permitting process, to read the opinion. Lost within the sensationalism surrounding the Standing Rock case, is the chilling message being sent to energy companies who attempt to build our energy infrastructure. Also, I don’t think we should look the other way when the Executive branch of government changes the rules at the end of the game. I don’t think we will like the place such a path will take us.