6/25/18 - Swap Dealers Face Challenges in Counterparty Onboarding
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6/25/18 - Swap Dealers Face Challenges in Counterparty Onboarding

Swap dealers are confronting major compliance demands when onboarding new trading counterparties for swap transactions. The U.S. National Futures Association, the self-regulatory organization tasked with the registration and oversight of swap dealers, continues to examine U.S. swap dealers and has recently begun examinations of foreign swap dealers. These examinations, which in some cases last as long as six months, cover a range of requirements contained in Section 4s of the Commodity Exchange Act (as amended by the Dodd-Frank Act) — requirements spanning risk management, reporting, business-conduct standards, and elective initial-margin segregation. Onboarding is not an explicit area of exam coverage, but swap dealers have nonetheless discovered that weaknesses in their counterparty onboarding process are negatively affecting their compliance with the Section 4s requirements — with the business-conduct standards and requirements for the exchange of margin, elective initial-margin segregation, and regulatory reporting, in particular.

A well-designed, effective swap dealer onboarding process is necessary to ensure that swap dealers identify in-scope counterparties, execute the correct legal agreements, and make the required disclosures and notifications to the appropriate parties. Swap dealers should also increase their focus on the development, implementation, and assessment of pre- and post-trade controls that support their onboarding process, as well as dedicate additional resources to the creation and maintenance of counterparty static data.

1) Identification of In-Scope Counterparties

Identifying in-scope counterparties is critical for determining the types of legal agreements required for the counterparty relationship. Swap dealers, especially non-U.S. swap dealers, should identify their in-scope counterparties at the point of onboarding. Swap dealers should have well-defined cross-border representation letters and clear policies for International Swaps and Derivatives Association self-disclosure letters (along with an effective way of assessing implementation of those policies).

2) Legal Agreements and Documentation

Swap dealers should consider maintaining an inventory, checklist, and/or process flow detailing the counterparty documentation required at client onboarding for a swap transaction. In addition to master netting agreements, swap dealers may need to execute ISDA Protocol 1, ISDA Protocol 2, a credit support annex, and an account control agreement with a swap counterparty. Swap dealers should also be aware that certain lines of business (e.g., prime brokerage) require additional legal agreements and ISDA protocols.

While swap dealers are able to leverage data provider Markit to execute ISDA Protocol 1 and ISDA Protocol 2, swap dealers should ensure that an onboarding team reviews counterparty representations and elections made on Markit for completeness and reasonableness. In addition, swap dealers should have bilateral agreements available for counterparties that are not on Markit.

3) Required Disclosures and Notifications

While many of the required disclosures and notifications are available on Markit, swap dealers should have written processes to deliver material information disclosures to new counterparties. Swap dealers should also have written processes and controls for notifying off-Markit counterparties of elective initial-margin segregation.

4) Pre- and Post-Trade Controls

Swap dealers should confirm the existence of all required documentation with a counterparty and that the swap dealer has made the required disclosures and notifications prior to executing a swap. The NFA will not tolerate multiple transactions with a counterparty that has not been fully onboarded for swaps, and expects that swap dealers will implement pre- and post-trade controls to confirm that a counterparty is fully onboarded for swaps prior to trading. Many swap dealers have implemented pre-trade tools for vetting counterparties, as well as processes that allow the front office to determine whether the counterparty has been fully onboarded for swaps. Other swap dealers are finding that their manual pre-trade counterparty checks and associated tools require enhancement — and potentially automation. Swap dealers should complement the pre-trade controls with post-trade controls (such as breach reports) to identify transactions with counterparties that were not fully onboarded for swaps. Swap dealers should have procedures that detail the steps for exiting a transaction and preventing future transactions, or expediting the onboarding process for the new counterparty, upon identification of a breach.

5) Static Data

Swap dealers must collect complete and accurate information about counterparties, and make sure that they represent this information correctly in their systems. Inaccurate counterparty static data (such as incorrect U.S.-person status) in a system can cause issues of noncompliance in downstream processes, such as the implementation of the business-conduct standards and reporting. Once the onboarding process is complete, swap dealers must periodically review and reconcile their counterparty static data. In addition, swap dealers should encourage their employees to voice concerns about counterparty classification and the completion of static data.

Deficiencies in swap dealers’ onboarding processes can affect a number of associated areas and ultimately result in material noncompliance and exposure to regulatory scrutiny. Swap dealers should ensure that their onboarding processes are comprehensive, operate effectively, and meet all of the compliance demands described above.

How Promontory Can Help

In previous engagements with swap dealers, Promontory’s markets-businesses solution center has assessed the design and operating effectiveness, developed target operating models, and assisted in the implementation and remediation of clients’ onboarding processes. Members of the solution center combine extensive industry experience with deep regulatory knowledge to provide clients with practical solutions to key issues and insight into industrywide challenges and regulators’ concerns.

A former U.S. Office of the Comptroller of the Currency senior deputy comptroller for capital markets, who is currently a member of the NFA’s board and serves on its compliance and risk committee, co-leads the solution center. The solution center also includes a former chief compliance officer of Santander’s swap dealer in the U.K. and compliance professionals with hands-on experience assisting swap dealers in all matters related to registration, compliance, and exam preparation.

Please contact Promontory to discuss how we can assist your firm with any of the onboarding challenges commonly faced by swap dealers.


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Munib Ali
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Doug Harris
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+1 212 365 6568

DJ Hennes
Senior Principal
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+1 212 365 6989