ISDA has prepared this brief summary of frequently asked questions to assist in your consideration of the ISDA 2010 Short Form Hire Act Protocol (the "Protocol").
THIS FREQUENTLY ASKED QUESTIONS DOES NOT PURPORT TO BE AND SHOULD NOT BE CONSIDERED A GUIDE TO OR AN EXPLANATION OF ALL RELEVANT ISSUES OR CONSIDERATIONS IN CONNECTION WITH THE PROTOCOL. PARTIES SHOULD CONSULT WITH THEIR LEGAL ADVISERS AND ANY OTHER ADVISER THEY DEEM APPROPRIATE PRIOR TO USING OR ADHERING TO THE PROTOCOL. ISDA ASSUMES NO RESPONSIBILITY FOR ANY USE TO WHICH ANY OF ITS DOCUMENTATION OR OTHER DOCUMENTATION MAY BE PUT.
How does the HIRE Act affect Equity Swaps?
The Hiring Incentives to Restore Employment Act (the “HIRE Act”), enacted in the US on March 18, 2010, imposes US withholding tax on certain payments referred to as “dividend equivalent payments,” made to non-US persons under certain types of notional principal contracts (“equity swaps”), effective for payments made on or after September 14, 2010, regardless of when the swap was entered into. “Dividend equivalent payments” include payments under an equity swap that are determined by reference to dividend payments on a referenced US equity security. Of particular interest here, this new US withholding tax on dividend equivalent payments applies to equity swaps where physical shares are transferred between the swap counterparties in connection with the opening or closing of the swap and where the referenced US equity security is not readily tradable on an established securities market. For example, if a party to an equity swap buys or sells the underlying referenced US equity security from its counterparty (i.e., crosses in or crosses out) in connection with the swap, the dividend equivalent payment will be subject to US withholding tax. In addition, the US Department of the Treasury (“Treasury”) may expand the types of derivatives subject to withholding at any time; further, under the HIRE Act, all cross border dividend equivalent payments on all equity swaps will be subject to US withholding tax beginning March 18, 2012, unless Treasury publishes guidance to exempt swaps with certain characteristics from the withholding requirement.
What is the purpose of the 2010 Short Form HIRE Act Protocol?
The 2010 Short Form HIRE Act Protocol (the “Short Form Protocol”) is being published to lessen the administrative burdens involved with amending a large population of pre-existing Standard ISDA Documentation. Such amendments address the enactment of new US withholding tax rules for equity swaps under the HIRE Act. Existing Standard ISDA Documentation generally allocates the risk of withholding taxes to the payer with the ability to terminate agreements if the payer is required to pay an increased amount due to a Change in Law. Generally, the payer is not required under its local law to withhold tax on most equity swap payments. Due to enactment of the HIRE Act, however, US tax law now requires the payer to withhold tax in certain situations. In addition, as the applicability of the withholding tax under the HIRE Act to dividend equivalent payments is in many cases in the control of the payee and not the payer, the Short Form Protocol specifically addresses this allocation of risk between the Long Party and the Short Party to the equity swap.
Who drafted the Short Form Protocol?
The language of both the 2010 HIRE Act Protocol (the “Original Protocol”) and Short Form Protocol are the result of extensive discussions that have involved ISDA’s North American Tax Committee, members of the Managed Funds Association (the "MFA"), and legal counsel retained by the MFA. In addition, numerous discussions with individual market participants and legal advisors who represent market participants were conducted throughout the process. As with all ISDA Publications the goal of the project was to have language that has been reviewed and commented on by many different market participants reflecting different market perspectives.
Why is ISDA publishing the Short Form Protocol?
Although the original Protocol was published after significant market input, it has not been widely utilized by a full range of market participants. Based on feedback that has been received since its publication, ISDA, with input from its North American Tax Committee, the MFA, individual market participants and legal advisors who represent market participants, revised the original Protocol in order to address market concerns with the expectation that the Short Form Protocol will achieve wider market acceptance.
What if I adhere to both the Original Protocol and the Short Form Protocol?
The terms of the Short Form Protocol provide that with respect to any other Adhering Party that also adhered to the Original Protocol, the Short Form Protocol will supersede in all respects the Original Protocol.
What are the differences between the original Protocol and the Short Form Protocol?
The Short Form Protocol has deleted references to the Foreign Account Tax Compliance Act (“FATCA”) portion of the HIRE Act (i.e., the new chapter 4 of the Internal Revenue Code of 1986) as well as the additional termination rights. In addition, the Short Form Protocol includes revised language to better accommodate transactions in which one of the parties is a dealer in derivatives located outside the US.
The Short Form Protocol deletes Paragraphs 2, 3, 6 and 9 of the Attachment to the original Protocol in their entirety and makes a conforming deletion to Paragraph 5. These deletions result in the removal of the additional termination events that were created in the original Protocol in addition to the provisions that addressed FATCA, which becomes effective January 1, 2013.
The payment mechanics added by Paragraph 1 of the Attachment have been redrafted for greater clarity.
A new defined term of “Dealer” has been added to the agreement.
A new representation to be given by the Short Party has been added.
Why does the Short Form Protocol provide an exception from the Market on Open (“MOO”) and Market on Close (“MOC”) Payee Representations for Dealers?
In the swap market, it is customary for a Dealer in swaps to hedge its book in the ordinary course of its business as a market maker who stands ready to execute client trades. Dealers customarily hedge in both the physical and derivative markets, and Dealers may hedge on a position-by-position or on a portfolio basis. Dealers routinely execute trades in both the physical and derivative markets at MOO and MOC pricing as part of this hedging practice (e.g., to rebalance positions or to satisfy regulatory requirements). Given this industry practice, it is not feasible for a Dealer to make representations regarding its hedging activities in the physical markets in connection with a swap that is priced at MOO or MOC. Nevertheless, so long as the non-Dealer is not transacting in the physical markets in connection with a swap that is priced at MOO or MOC, the Dealer’s inability to make representations regarding its hedging activities should have no significance to the tax treatment of a swap under the HIRE Act.
Why is the Short Party being asked to give a Payer representation on its actions?
As discussed above, it is not feasible for a Dealer to make representations regarding its hedging activities in the physical markets in connection with a swap transaction that is priced at MOO or MOC. This is true whether the Dealer is the Long Party or the Short Party to the swap. However, a non-Dealer should be able to make such a representation absent rare or unusual circumstances. Consequently, where the Long Party to a swap is a non-US Dealer and that swap is priced at MOO or MOC, the Short Party to the swap should represent that it is not transacting in the physical markets at MOO or MOC to reduce the risk of there being a deemed “transfer” of physical shares from one swap party to the other within the meaning of the HIRE Act. It is hoped that Treasury will clarify the meaning of “transfer” of physical shares in connection with a swap as that term is used in the HIRE Act and also clarify the proper tax characterization of swaps that are priced at MOO or MOC when it publishes guidance under the HIRE Act. However, until that guidance is published, the Short Party to the swap should make this representation so that the withholding tax treatment of any dividend equivalent payments is clear to both parties to the swap. It is anticipated that, if in a particular swap a non-Dealer is unable to make representations regarding MOO or MOC, the parties will address this matter in the trade confirm.
If I adhere to the Short Form Protocol, will the provisions of the Short Form Protocol apply to all of my Transactions documented under ISDA Agreements?
The original Protocol applied to all Transactions documented under ISDAs where both parties adhered to the Protocol. Under the Short Form Protocol, the change to the definition of Indemnifiable Tax affects all payments made on or after the Implementation Date, whereas the representations added by the Short Form Protocol apply with respect to Transactions entered into, or terminated, on or after September 14, 2010.
Adherence Letter Submission Process
When do I need to send in my Adherence Letter?
The Protocol opens on November 30, 2010. There is no closing date. ISDA does however reserve the right to designate a cut-off date by giving 30 days notice on this site.
How do I send in my Adherence Letter?
All Adherence Letters must be delivered by email to email@example.com. In the email, you must submit both your conformed and executed copies of the Adherence Letter.
The Adherence Letter(s) should be on your institution’s letterhead. Nothing in the form Adherence Letter available on ISDA's website may be changed with the exception of completing the details of your institutional name, date and signature block.
You are not required to send your original Adherence Letter(s) by mail to ISDA.
What is a conformed copy?
A conformed copy of the Adherence Letter means that the name of the authorized signatory (for example, Patricia Smith) is typed rather than having Patricia Smith’s actual signature on the letter. ISDA only posts on its website the conformed copy of all Adherence Letters.
You must also submit an executed, or signed, copy of the Adherence Letter in addition to the conformed copy of the Adherence Letter. ISDA keeps the executed copy of the Adherence Letter for its files and does not share the executed copy with anyone else.
Who is an authorized signatory?
An authorized signatory to the Adherence Letter is an individual who has the legal authority to bind the adhering institution.
What if I am an investment or asset manager – how do I complete the signature block?
If you are an investment or asset manager and act on behalf of multiple funds, you must indicate the following in the signature block: "Investment/Asset Manager, acting on behalf of the funds and accounts listed in the relevant Master Agreement between it and another Adhering Party". A separate Adherence Letter for each fund or account does not need to be submitted to ISDA. Further, no specific names of clients of the investment/asset manager will be publicly disclosed on the ISDA website in connection with the Protocol.
Can I change the text of the Adherence Letter?
No. The Adherence Letter must be in the same format as the form letter published in the ISDA 2010 Short Form Hire Act Protocol. You may obtain a copy of the form Adherence Letter by visiting the ISDA website, www.isda.org and clicking on "ISDA 2010 Short Form Hire Act Protocol" and then clicking on "Form of Adherence Letter".
Limited Right of Revocation
Can I revoke my participation in the Protocol?
No. Once an Adherence Letter has been accepted by ISDA, an Adhering Party is bound by all amendments with other parties that have already adhered to the Protocol or, subject to the discussion below, that adhere before a designation of the Annual Revocation Date.
An Adhering Party may, at any time during the period from October 1 to October 31 of a calendar year, deliver to ISDA a notice specifying the Annual Revocation Date as its cut-off date in respect of amendments with future Adhering Parties. The effect of such a letter will be to withdraw adherence for future Adhering Parties as of December 31 in that calendar year. Although amendments already made will not be revoked, any subsequent adherence by new Adhering Parties after the designated Annual Revocation Date, will not bind the party that has submitted a Revocation Notice.
You can, however, bilaterally agree to amend your Covered Master Agreement with your counterparty (the other Adhering Party) and any such subsequent amendments will supersede those made by the Protocol to the extent that they are inconsistent.
Does it cost any money to adhere to the Protocol?