End Users Of OTC Derivatives Win Exemptions On Collateral

by Glen Shapiro, LawAndTax-News.com, New York

12 October 2009

Large non-financial companies, especially oil and airline groups, that traditionally use the derivatives markets to hedge their risks, stand to gain an important exemption as the reforms of the over-the-counter derivatives markets are revised to take account of practical problems.

House Financial Services Committee Chairman Barney Frank has released draft legislation which is designed to regulate more effectively the USD592 trillion derivatives market. It requires the most common and actively traded over-the-counter (OTC) derivatives contracts to be traded on recognized exchanges or processed through a regulated trading platform.

However, the draft bill proposes that a requirement for OTC swaps to be cleared would not apply if 'one of the counterparties to the swap is not a swap dealer or major swaps participant'. This obviates extra cash collateral requirements that major industry and commercial bodies had lobbied against. Exempted transactions would still be reported to the regulators to maintain an overview of the market and enable market data to be published.

Non-financial companies tend to trade derivatives directly with banks, for which credit lines are usually made available or special collateral requirements apply. If centralised clearing were imposed, the system would involve cash or liquid assets such as US Treasury debt as collateral placed for margin security, and this additional imposition could have had far reaching effects on overall corporate liquidity at this time of general shortage.

Rep. Frank has announced that his committee will discuss the OTC derivatives legislation in mid October and expected that the bill would be moved to the House floor by the end of the month.

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