On 6 May 2013, ISDA published the Derivatives/FX Prime Brokerage Business Conduct Allocation Protocol to help prime brokers and executing dealers comply with the Dodd-Frank External Business Conduct Rules (“EBC”) which became effective on 1 May 2013.
Broadly, in a prime brokerage situation, the prime broker may (i) grant limited agency powers to the counterparty to negotiate transactions with approved counterparties (“executing dealers”); or (ii) specify parameters within which the counterparty can enter into approved transactions with executing dealers on a non-agency basis which are subsequently “given up” by the executing dealer to the prime broker.
Unfortunately, the mechanics of prime brokerage create specific compliance issues with respect to the EBC Rules. Market participants have commented that it is impracticable for prime brokers and executing dealers to fully comply with the EBC Rules, which require certain information (including pre-trade mid-market quotes and risk disclosures) to be provided to clients. This is due to the fact that both the prime broker and the executing broker only possess the information relating to its portion of a transaction and cannot access the information held by the other which is needed in order to comply with the EBC Rules.
In response, on 30 April 2013, the CFTC released a time-limited no-action letter (No. 13-11). This expires on 15 May 2013 but, in the interim, provides relief to prime brokers and executing dealers that are both swap dealers (SDs) and that enter into prime brokerage agreements to trade “Covered Transactions” being either:
- swaps that are not required to be cleared under Section 2(h)(1)(A) of the Commodity Exchange Act (CEA); or
- 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 (“Exempt FX Transactions”). These instruments are still subject to the EBC Rules despite being exempt from the clearing and trading requirements.
The purpose of the ISDA protocol is to enable SDs that are parties to prime brokerage arrangements as prime broker and executing broker to incorporate into those agreements an apportionment of responsibilities for compliance with obligations under the EBC Rules.