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Derivatives End-Users Fear Margin Requirements Could Hurt Capex

  • By Konstantine Kastens, AFP Public Policy Analyst
  • Published: 4/4/2014
A majority of U.S. companies who use over-the-counter OTC derivatives for hedging purposes reported that imposed margin requirements would hurt business capital expenditures, according to a recent survey.  

The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act requires that that the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) issue rules that enhance transparency and assure proper capitalization of the OTC derivatives market. The language of the law limited its scope to financial investment entities that used derivatives to make speculative trade bets, while allowing commercial business end-users that purchase swaps for financial risk management to be exempted. However, the rulemaking process has offered minimal guidance toward this distinction.

Legislation has been introduced in both the Senate and House of Representatives aiming to clarify the language of the Dodd-Frank law, by granting explicit protection to nonfinancial commercial end-users. Introduced in the House by Representative Michael Grimm (R-NY), H.R. 634, the Business Risk Mitigation and Price Stabilization Act, has received bipartisan support—as has its Senate companion bill, S.888, introduced by Senator Mike Johanns (R-NE).

A survey administered by the Coalition for Derivatives End-Users—a partnership of organizations representing corporate end-users, including AFP—analyzed 43 financial practitioners among various industries on how margin requirements could affect their businesses.  The results were unveiled during a public conference held on Capitol Hill, which included remarks by Senate bill author Sen. Johanns.

More than 67 percent of surveyed CFOs and corporate treasurers responded that margin requirements could hurt their companies’ capital expenditures. At 91 percent, almost all respondents agreed that the requirement would force changes to current hedging practices. To comply with margin requirements, the average respondent noted they would need to set aside $651.9 million in collateral.

The survey also found many companies that employ a centralized treasury unit (CTU) to execute OTC derivatives are unclear as to whether they are subject to clearing requirements for their trades.  Last summer, the CFTC issued no-action enforcement for commercial end-users on clearing requirements. As such, this exception may not be applicable to some companies that use CTUs to execute swaps for risk mitigation purposes. Specifically, the survey indicated one-third of respondents were nonfinancial affiliates to independent CTUs and likely subject to clearing requirements. Of those respondents, 85 percent reported not knowing whether the CFTC no-action relief extended to their circumstances.

Meanwhile, European companies are in their third month of compliance with European Market Infrastructure Regulation (EMIR) OTC derivatives reporting. The requirement for commercial end-users in Europe to report swaps trade transactions and backlog past activity with repositories has created challenges many argue are even more demanding than obligations imposed by Dodd-Frank. Since implementation, European regulators have had to clarify many obligations, while businesses hobble toward compliance.

As part of the Coalition for Derivatives End-Users and through public comments, AFP remains a committed voice in favor of protecting nonfinancial commercial businesses’ ability to utilize swaps markets for financial risk management. AFP supports global efforts by lawmakers to strengthen OTC derivatives markets and enhance transparency. Equally so, AFP urges for rules that recognize the distinction between plain vanilla responsible risk mitigation practices and speculative high-risk market bets.
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