FEPs & RISK CURVES
known over time, the hedge curves will also change to reflect the volumes that have already been effectively priced.
2. CFTC’s FEP Guidelines: Swaps & Swaptions As part of Dodd-Frank the CFTC has started
introducing a large set of rules that will impact how firms operating in energy and commodity markets hedge market risk. Under DF a swap is generally defined as a financial
transaction where one party agrees to exchange a fixed price for a floating price with respected to a notional quantity of a commodity. In a swap, there are no natural ‘sellers or buyers’ to the extent that either party could be obligated to pay depending on the final settlement of the floating leg of the swap. Physically settled forward contracts are generally excluded from the definition of a swap. DF provides an exception to the mandatory
clearing requirement for end-users (the “end-user exception”). These exceptions apply to firms that use swaps to hedge or mitigate commercial risks. Non financial end-users, at their discretion, may elect not to clear a swap that would otherwise be required to be cleared by notifying the CFTC.
Issue Clearing Swap Data Reporting
Confirmation & Documentation Standards for Swaps
Credit Support
Pre-Dodd-Frank & Transition Swap Reporting
single-month and all-months-combined limits that would apply across classes, as well as single-month and all-months-combined position limits separately for futures and swaps) are set for each referenced contract at 10% of open interest in that contract up to the first 25,000 contracts, and 2.5% thereafter. In a survey conducted amongst major swap
counterparties, the CFTC found that when combining exchange-traded and OTC positions, several large institutions exceeded the exchange position limits on a regular basis. The CFTC estimates that forty energy traders may be affected by the proposed spot-month position limits and ten energy traders may be affected for all-months- combined and single-month position limit. Traders with positions above the reporting threshold will be required to submit position reports daily, in similar fashion to the current system in place for futures and futures-equivalent positions.
Futures Equivalent Position The futures equivalent month of a swap is a way
of representing the price risk exposure of a swap in terms of the underlying futures contracts that best match that price risk exposure. Even though the FEP metrics are similar in nature to the risk or
Table 2: Dodd-Frank Implications For Swap End Users Implications
End-users can opt-out of mandatory clearing and also have the option to clear any OTC transactions
End-users need to maintain records with swap transactions and report them to CFTC
New standards for swaps confirmation and documentation for swap dealers to be introduced by CFTC
End-users need to enter into credit support document (e.g. Credit Support Annex of ISDA master agreements) for swaps not cleared
For ‘historical swaps’ with trade dates before DF was passed and between the passage and the issuance for the final rules, certain disclosure requirements still apply to ensure that regulators have access to that data through swap data repositories (SDRs)
However, financial end-users will be required to
clear and execute swaps in the same manner as swap dealers and major swap participants. The CFTC has also established limits on positions
in physical commodity futures contracts and other economically-equivalent derivatives “to prevent excessive speculation and manipulation while ensuring sufficient market liquidity and efficient price discovery.” The position limits for spot-month positions are 25% of deliverable supply for a given commodity, with a conditional spot-month limit of five times that amount for entities with positions exclusively in cash-settled contracts. For non spot-month positions the limits (aggregate
84 June 2012
hedge curves presented in the prior section, the objective of the CFTC is to have an aggregate view of exposures, and not a set of ratios that determine how to hedge those exposures. There are several types of futures equivalent
positions calculations depending on the underlying reference prices of the swap.
A) Swap Linked to a DCM Swaps directly or indirectly priced off of
a Designated Contract Market (e.g. futures exchanges) can be easily converted to futures equivalents applying the following rules. First, the notional quantity of the swap is then apportioned
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