ISDA put out a great summary of some of the key issues on the future of clearing OTC derivatives versus the current benefits of bilateral collateral arrangements that exist today (http://isda.derivativiews.org/2012/04/24/the-bilateral-world-vs-the-cleared-world/), highlighting additional margin, capital charges, documentation and players.

There has been much discussion already about the initial margin hit that end-users will take and hopefully the Senate will pass the House bill to exempt end-users from the margining requirements under Dodd-Frank.  The time and costs to get the legal documentation in place has probably not been fully realized by non-financial end-users as most do not have CSAs in place and the concept will be new to them, whether it’s for clearing or bi-lateral.

The billion dollar question is whether all of these costs borne by Swap Dealers and clearing firms, and passed on to end-users as well as end-users’ own costs, will be offset by the benefits of greater transparency and liquidity derived from these regulations.  Time will tell, but I expect that the proposed benefits, should they materialize, will be many years away for end-users.

This week the U.S. House of Representatives voted 370-24 to amend Dodd-Frank to allow non-financial end users to be exempt from being required to post margin for OTC derivative trades. If you were following the saga of the final passage of Dodd-Frank, you may recall that, at the 11th hour, the margin exemption wording was pulled, leaving behind just the end-user clearing exemption. I assumed this was an attempt at trying to make the legalese more efficient, because if you don’t have to clear your trade, why would you post margin.

Well after the Fed and CFTC came out with draft margin rule proposals, it seemed clear that the intent was to protect the financial system by having trades that don’t clear backed by margin. The end-user community got to work and lobbied to put the exemption back in, so maybe the system does work.

It is hard to imagine that the Senate would not pass the amendment, so hopefully President Obama will be able to sign it into law soon. However, I believe that Swap Dealers may still want to collect margin for un-cleared trades to lower their capital charges; otherwise, they would have to charge more through a wider bid-offer spread or additional fees. In order to avoid the hassle of complying with un-cleared trades, some Swap Dealers may decide not to offer hedges that won’t clear. In the end, the economics of clearing vs. not clearing your trade may drive you to post margin to Swap Dealers, even if the law doesn’t require you to do so.

The CFTC has passed the three rules that make up the requirements for reporting swaps to Swap Data Repositories (SDRs) under Dodd-Frank. One cause for concern is the effective date for reporting could be as early as July 16, 2012. Although it should not be too surprising that the effective date was set to the second year anniversary of Dodd-Frank, Swap Dealers were certainly hoping for more time and more phasing in of the data reporting vs. the real time reporting requirement, which also has the same effective dates.

Many Swap Dealers have not invested too much time in preparing as the Swap Dealer and Swap definitions have not be finalized. Understanding this, the rules allow for an extension to be later than July if those definitions have not been issued in time. They have also allowed a phasing in of commodities, Fx and equity derivatives 90 days later, with credit and interest rates going in at the effective date, and another 90 days thereafter for any non-Swap Dealer or non-MSP to report.

The rules also drive reporting to come from Swap Execution Facilities (SEFs) and Derivative Clearing Organizations (DCOs), which is key for real time reporting and which most likely will be driven from these types of market participants. However, rules for SEFs and DCOs have also not been issued, and these entities will have their hands full registering and complying for their own rules, let alone figuring out how to report to SDRs.

Finally the biggest challenge is that no SDR has been given any provisional approvals today. It is hard to see how Swap Dealers, MSPs, SEFs and DCOs can realistically and properly plan and implement a technology undertaking of this magnitude without having SDRs approved, let alone ready to go themselves. Anything less than six months would be challenging, to say the least, for a Reporting Entity to be ready, and the clock is ticking fast.