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ISDA Prepares Protocol for Intermediated FX Transactions


In a letter to the CFTC dated 27 June 2013, a number of market participants highlighted the practical challenge in complying with certain Dodd-Frank External Business Conduct Standards (“EBCS”) in the context of intermediated prime brokerage arrangements relating to (i) non-cleared foreign exchange swaps, and (ii) physically-settled foreign exchange forwards and swap agreements that have been exempted from the definition of swap by the U.S. Department of the Treasury (together “Covered Transactions”).

Broadly, intermediated prime brokerage arrangements involve the presence of an intermediary (the “FX Intermediary”) which is granted limited agency powers by a prime broker and which intermediates between a counterparty and an executing dealer in relation to a Covered Transaction.  Provided that the terms of the Covered Transaction conform to the limited powers granted to the FX Intermediary by the prime broker (e.g. in terms of being executed with an approved counterparty and an approved executing dealer), the Covered Transaction is then eligible to be given up to the prime broker.  The benefits of such arrangements include the maintenance of counterparty anonymity and the provision of access to larger pools of executing dealers, leading to better pricing.

The Problem

In a typical intermediated prime brokerage arrangement:

  • only the FX Intermediary will know the identity of the counterparty prior to execution of the Covered Transaction;
  • the executing dealer will not know the identity of the counterparty; and
  • only the prime broker will maintain credit and other portfolio information regarding the counterparty.

Given this, it is argued that the prime broker is in the best position to take responsibility for compliance with the EBCS that relate to the general relationship between a Swap Dealer (“SD”) and its counterparty, such as “know-your-counterparty” obligations, while the FX Intermediary is in the best position to take responsibility for compliance with transaction-specific EBCS, such as providing pre-trade mid-market quote and risk disclosures.

The Solution

On 27 June 2013, the CFTC issued No Action Letter No. 13-39, which provided no-action relief for Covered Transactions involving FX Intermediaries.  The letter allowed SDs to allocate EBCS obligations to a non-SD acting as an FX Intermediary, so long as the FX Intermediary is registered with the CFTC as an Introducing Broker or a Futures Commission Merchant (or is a registered SD but acts in the role of an Introducing Broker without registration as such pursuant to CFTC Letter 12-70) (a “Registered Intermediary”).

In order to allows SDs and Registered Intermediaries time to put in place necessary documentation and provide requisite notices, the CFTC confirmed in No Action Letter No. 13-39 that it would not commence enforcement action against SDs with respect to Covered Transactions with a counterparty executed under an intermediated prime brokerage arrangement to the extent any such obligations have been allocated to a Registered Intermediary, for failure to comply with obligations under:

  • §23.402(d)-(f) (Reasonable reliance on representations, Manner of disclosure, and Disclosures in a standard format, respectively);
  • §23.431 (Disclosures of material information);
  • §23.432(b) (Clearing disclosures for swaps not required to be cleared—right to clearing);
  • §23.434 (Recommendations to counterparties–institutional suitability);
  • §23.440 (Requirements for swap dealers acting as advisors to Special Entities);
  • §23.450 (Requirements for swap dealers and major swap participants acting as counterparties to Special Entities); and
  • §23.451 (Political contributions by certain swap dealers)

(together the “Relevant Obligations”).  However, relief is subject to certain conditions, including that:

  • no Relevant Obligations are left unallocated between SD and Registered Intermediary;
  • the relevant underlying counterparty is provided with notice of the allocation of the Relevant Obligations; and
  • the allocation of the Relevant Obligations is in writing and includes an agreement by the SD and Registered Intermediary that, inter alia, the counterparty will be provided with no less than 30 days’ notice of any expiration of the allocation of Relevant Obligations.

The CTFC’s current non-enforcement stance expires on 19 July 2013.   Accordingly, ISDA is due to publish its “Derivatives/FX Prime Brokerage Business Conduct Allocation Protocol for Intermediated FX Transactions” (the “Protocol”) on 12 July 2013.  Whilst a ‘one size fits all’ approach, which may not be suitable for all market participants, the Protocol will allow signatories to provide the necessary confirmations regarding status and allocate Relevant Obligations in a way that will facilitate compliance with the EBCS.

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