Management: Swap Rules Tighten

April 2, 2013 09:23 PM

But new regs also offer new flexibility

If you manage some or all of your risk in the over-the-counter (OTC) "swap" market, your life might get a bit more complicated—and potentially more expensive. But the new rules also present some new opportunities.

Under the so-called "Dodd/Frank" legislation, farmers who participate in the newly regulated world of swaps will now have to abide by record-keeping rules and potential margin requirements.
The increased regulation comes as a direct result of the 2007 to 2009 world-wide financial crisis, where individuals lost untold billions in the swap markets.

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Important note: The rules are mostly unchanged for exchange traded futures and options contracts. Cooperatives are also exempt from the swap dealer definition, though still are subject to some rules. Forward contracts continue to be excluded from the definition of a swap, so farmers doing forward contracts with cooperatives or proprietary companies will be exempt.

But farmers who use swaps—through registered swap dealers, brokerage firms, banks, cooperatives or proprietary dairy processors—will be subject to the new rules. Those rules, requiring compliance later this spring and summer, will impose more record keeping duties and
require more detailed reporting of the swap trades.

Records must be maintained for five years and kept in a form that is deliverable to regulators within five business days after the request is made. For some, that might prove to be a challenge.

"Dodd/Frank assumes everyone is wired, but in agriculture, that’s not necessarily true," says Rene Friedman, vice president and global head of legal and compliance for INTL FCStone, Inc.
To take advantage of special rules for end-use customers, farmers will also need to keep records establishing they actually hold or produce the physical commodities that they’re hedging. That’s to ensure they are conducting true hedges, she says.

For the vast majority of dairy farmers, however, Dodd/Frank won’t be a big deal, says Sara Dorland, managing partner of Ceres Risk Management.

The Dodd/Frank legislation was passed in 2010, and the original ramifications appeared ominous for the dairy industry. But subsequently released rules and exceptions are far less of a concern for most market participants, she says.

"If you have forward dairy contracts [with a cooperative or propriety firm] that are cash settled, there may be more involved," Dorland says. "But if the contracts go to delivery, they will continue to be viewed as forward contracts and be excluded from these rules."

The new Dodd/Frank regulations also open up swap opportunities to more farmers. In the past, an individual needed $10 million of net worth before he or she could participate in certain swaps, such as risk managing fuel prices. That put swap opportunities out of reach for most dairy farmers, says Ed Gallagher, president of Dairy Farmers of America (DFA)’s Risk Management division. Now, just $1 million of net worth is required.

This means more farmers will be able to participate in swaps to risk manage fuel, corn silage and even cull cows.

"The new regulations give us quite a bit more flexibility," he says. "We’re in a better place under the new regulations to help more members."

Dorland, Friedman and Gallagher advise farmers to contact their brokers, cooperatives or swap partners to ensure they are meeting the new requirements that come into play this spring and summer.

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