E TUT WALL ST. AND THE LAW: I CUSTOMER FUND PROTECTIONS ST AFTER THE COLLApsE OF MF N GLOBAL AND PEREGRINE – WHAT REGULATORY CHANGES ARE TAKING PLACE Prepared in connection with a Continuing Legal Education course presented at New York County Lawyers’ Association, 14 Vesey Street, New York, NY presented on Tuesday, June 18, 2013. P ROGR A M C O - S P O N SOR : New York Law (NYLS) School Financial Services Law Institute P ROGR A M M OD E R A TOR : Prof. Ronald H. Filler, NYLS Professor of Law and, Director, Financial Services Law Institute, NYLS P ROGR A M F ac U L T Y : Steven Lofchie, Cadwalader Wickersham & Taft; Robert L. Sichel, Pacific Global Advisors; Gary DeWaal , Gary DeWaal & Associates (former Group General Counsel of Newedge) NYCLA-CLE I 2 TRANSITIONAL & NON-TRANSITIONAL MCLE CREDITS: This course has been approved in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 2 Transitional & Non-Transitional credit hours: .5 Ethics; 1.5 PP This program has been approved by the Board of Continuing Legal Education of the Supreme Court of New Jersey for 2 hours of total CLE credit. Of these, 0 qualify as hours of credit for Ethics/Professionalism, and 0 qualify as hours of credit toward certification in civil trial law, criminal trial law, workers compensation law and/or matrimonial law. Information Regarding CLE Credits and Certification Wall Street and the Law June 18, 2013; 6:00 PM to 8:00 PM The New York State CLE Board Regulations require all accredited CLE providers to provide documentation that CLE course attendees are, in fact, present during the course. Please review the following NYCLA rules for MCLE credit allocation and certificate distribution. i. You must sign-in and note the time of arrival to receive your course materials and receive MCLE credit. The time will be verified by the Program Assistant. ii. You will receive your MCLE certificate as you exit the room at the end of the course. The certificates will bear your name and will be arranged in alphabetical order on the tables directly outside the auditorium. iii. If you arrive after the course has begun, you must sign-in and note the time of your arrival. The time will be verified by the Program Assistant. If it has been determined that you will still receive educational value by attending a portion of the program, you will receive a pro-rated CLE certificate. iv. Please note: We can only certify MCLE credit for the actual time you are in attendance. If you leave before the end of the course, you must sign-out and enter the time you are leaving. The time will be verified by the Program Assistant. Again, if it has been determined that you received educational value from attending a portion of the program, your CLE credits will be pro-rated and the certificate will be mailed to you within one week. v. If you leave early and do not sign out, we will assume that you left at the midpoint of the course. If it has been determined that you received educational value from the portion of the program you attended, we will pro-rate the credits accordingly, unless you can provide verification of course completion. Your certificate will be mailed to you within one week. Thank you for choosing NYCLA as your CLE provider! New York County Lawyers’ Association Continuing Legal Education Institute 14 Vesey Street, New York, N.Y. 10007 • (212) 267-6646 Wall St. and the Law: Customer Fund Protections after the Collapse of MF Global and Peregrine -- What Regulatory Changes Are Taking Place Tuesday, June 18, 2013; 6:00 PM to 8:00 PM Program Co-Sponsor: New York Law (NYLS) School Financial Services Law Institute Moderator: Prof. Ronald H. Filler, NYLS Professor of Law and, Director, Financial Services Law Institute, NYLS Faculty: Steven Lofchie, Cadwalader Wickersham & Taft; Robert L. Sichel, Pacific Global Advisors AGENDA 5:30 PM – 6:00 PM Registration 6:00 PM – 6:10 PM Introductions and Opening Remarks 6:10 PM – 8:00 PM Discussion New York County Lawyers’ Association Continuing Legal Education Institute 14 Vesey Street, New York, N.Y. 10007 • (212) 267-6646 Wall St. and the Law: Customer Fund Protections after the Collapse of MF Global and Peregrine -- What Regulatory Changes Are Taking Place Tuesday, June 18, 2013; 6:00 PM to 8:00 PM Program Co-Sponsor: New York Law (NYLS) School Financial Services Law Institute Moderator: Prof. Ronald H. Filler, NYLS Professor of Law and, Director, Financial Services Law Institute, NYLS Faculty: Steven Lofchie, Cadwalader Wickersham & Taft; Robert L. Sichel, Pacific Global Advisors Table of Contents OTC Clearing – What Do Pension Plan Fiduciaries Need to Know? Ask the Professor: What is the Impact on MF Global From the Recent UK Supreme Court Decision Involving Lehman Brothers International (Europe)? Ask the Professor: Portfolio Margining– How Will Dodd-Frank Impact its Utilization? Are Customer Segregated/Secured Amount Funds Properly Protected After Lehman? OTC CLEARING – WHAT DO PENSION PLAN FIDUCIARIES NEED TO KNOW? May 21, 2013 S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L Disclaimer This report is provided for informational purposes only. Do not use this report as a primary basis for investment decisions or for decisions pertaining to plan funding, accounting, or related regulatory requirements. In preparing this report, Pacific Global Advisors may have relied upon and assumed, without independent verification, the accuracy and completeness of information provided by various third parties such as investment managers. Pacific Global Advisors is not able to independently verify the accuracy and completeness of such information and makes no representation as to the information’s accuracy or completeness. This report may contain projections, forecasts or estimates. Pacific Global Advisors makes various assumptions in connection with such forward looking information. Actual events or conditions may differ from those assumed and not all relevant events or conditions may have been considered in developing the assumptions. Changes to the assumptions could have a material impact on the information presented herein. No representation is made that the performance presented herein will be achieved. Nothing contained herein should be construed as legal, actuarial or accounting advice. You must retain an actuarial firm which is independent of Pacific Global Advisors to provide all actuarial services with respect to statutory and regulatory requirements. Pacific Global Advisors and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters included herein (including any attachments) is not intended or written to be used, and cannot be used, (a) in connection with the promotion, marketing or recommendation of any of the matters addressed herein to another person or (b) for the purpose of avoiding U.S. tax- related penalties. This report summarized certain provisions of Title VII of the Dodd Frank Wall Street Reform and Consumer Protection Act. Pension Plan fiduciaries should discuss the Act’s implications for the plan’s specific situation with the plan’s legal advisors. STRICTLY PRIVATE AND CONFIDENTIAL O T C D E R I V A T I V E S C L E A R I N G 1 1 Agenda Background 2 Mechanics of OTC clearing 8 Key risk considerations 18 Portfolio impact, documentation, & next steps 27 Appendix I – Bonds vs. swaps, collateral transformation, fees 33 Appendix II – DOL Advisory Opinion 43 STRICTLY PRIVATE AND CONFIDENTIAL O T C D E R I V A T I V E S C L E A R I N G 2 Foreword The Dodd-Frank Wall Street Reform and Consumer Protection Act (Act) was enacted in July 2010 Title VII of the Act completely overhauls the regulation of derivative transactions Users of derivatives, such as pension plans, need to ensure compliance with this new regulatory scheme Pension plans widely use derivatives for hedging and other purposes whether it be: Directly by internal staff at the plan sponsor Directly by an external investment manager/QPAM in a separate account structure Indirectly by an external investment manager/QPAM in a commingled vehicle structure, such as a hedge fund According to the American Benefits Counsel, “Defined benefit plans use swaps to hedge their asset and liability risks. Without swaps, plan assets and liabilities would be far more volatile, leading to greatly increased funding volatility. Increased funding volatility would, in turn, force plan sponsors to set aside much greater reserves to address possible future funding obligations.” (American Benefits Council letter to the Department of Labor commenting on proposed ERISA regulations, February 3, 2011) Mandatory centralized clearing (processing, settling, and guarantying of trades) is one of the centerpieces of the Act’s goal of reducing risk in the derivatives marketplace This report summarizes certain provisions of Title VII. Pension Plan fiduciaries should discuss the Act’s implications for the plan’s specific situation with the plan’s legal advisors. STRICTLY PRIVATE AND CONFIDENTIAL O T C D E R I V A T I V E S C L E A R I N G 3 2 Background 2008 FINANCIAL CRISIS A series of large financial institution failures triggered a financial and economic crisis that threatened to freeze U.S. and global credit markets. As a result of these failures, unprecedented governmental intervention was required to ensure the stability of the U.S. financial system. The President’s Working Group on Financial Matters noted shortcomings in the OTC derivatives markets during the crisis. 2009 G-20 & INTERNATIONAL COMMITMENTS The financial crisis brought international attention to strengthening financial regulation through improved transparency.