European hedge funds may be unprepared for the implementation of the US Dodd-Frank Act on July 16, warns Gary DeWaal, senior managing director and group general counsel at Newedge.
Another area highlighted by DeWaal concerns funds engaging in bilateral swaps in energy or agriculture that may ultimately clear on, for example, ICE Europe. “Going forward because those clearing houses deal with US persons, they are going to have to be designated as clearing organisations or DCOs or something under the CFTC regulation, the key US regulator on this issue.”
The problem is that if a hedge fund is on the books of a UK broker and that broker clears the trades on the fund’s behalf with ICE Clear Europe, after July 15 that will not work. “Only US FCMs can be members of DCOs. This could cause a lot of dislocation,” he said.
If a pool or fund is a US person and not an ECP, it can only be a counterparty to certain US designated persons, including US-registered FCMs.
DeWaal warned there are other rules that are not obvious that are likely to hit European managers. For example, he said the elimination of certain private exceptions that currently exist will mean additional reporting and record keeping requirements and modification of the credit investors and qualified client provisions of the rules.
In addition the SEC is extending its anti-fraud reach to hedge funds deemed to be US hedge funds even if located outside the US. These funds will have to have a designated chief compliance officer (CCO) with specific skills and duties. An exemption within the US, known as Reg D, cannot be relied on if “you have any legal or regulatory history” or if anyone is registered as an investment advisor in the US”.
At the same time as the US is processing Dodd-Frank, the European Union continues to discuss proposals. Although many of these have been postponed, the intention is to have a standardised way of dealing with OTC transactions.
DeWaal is concerned that although the “general philosophies” are the same with the Group of 20 states that agreed to mandatory central clearing of OTC swaps by the end of 2012, the actual details of how this is to be done are unclear on both sides of the Atlantic. Although the picture is somewhat clearer in Europe, “we don’t know how it will happen in the US. So we don’t know exactly where the differences are yet as the rules and fine-tuning is not out. As time goes on there is no doubt there will be differences in the approach of the two continents and we can only hope we can narrow those differences,” concluded DeWaal.
Meanwhile, debate continues within the EU. Most recently a clause in the European market infrastructure regulation (Emir) text drafted by the European Parliament seems to state central counterparties (CCPs) must accept high-quality corporate bonds and gold as collateral. This new provision has been strongly criticised by clearing houses. They say they will only accept forms of collateral that meet their risk management standards.
The reaction is a result of confusion over the wording of the clause which seems to outline certain types of assets clearers will have to accept as collateral. According to the text, voted through the parliament’s economic and monetary affairs committee on May 24, a CCP will “accept highly liquid collateral, such as cash, gold, government and high-quality corporate bonds, with minimal credit and market risk to cover its initial and ongoing exposure to its clearing members”.
The European Securities and Markets Authority (Esma) is required by the draft Emir legislation to define technical standards on the type of assets that can be considered highly liquid. Some participants believe it is not the intention of parliament to force CCPs to accept every type of asset on this list.
A parallel Emir text being debated by the council simply states CCPs will accept highly liquid collateral and does not specify recommended assets. The council and parliament versions will have to be merged in trialogue with the European Commission later this year.
Additional reporting by Matt Cameron and Michael Watt, Risk magazine.