New Derivatives Rules To Increase Corporate Hedging Costs

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

24 September 2010

A recent study has found that, although language in the recently passed Dodd-Frank Wall Street Reform Act in the United States exempts corporate derivatives users from centralized clearing mandates, US companies that use commodities derivatives believe the new rules will increase their costs of hedging, and companies in Europe expect a similar result from forthcoming European Union (EU) regulations.

A press release from Greenwich Associates states that the results of its Market Pulse Study reveal that US companies that employ commodities derivatives expect to see an increase in commodities hedging costs regardless of the final outcome on the still open question about whether the new law will require corporate ‘end users’ to post margins on over-the-counter (OTC) swap transactions that are not centrally cleared.

Both bills in the US Senate and House of Representatives bills originally included a provision explicitly exempting commercial end-users from margin requirements in non-cleared swap transactions. That provision was dropped in the final law approved by both houses and signed by President Obama.

Although it was subsequently stated that the intent of legislators was in fact to exempt commercial end users from the margin requirements, it remains to be seen how US regulators will interpret and enforce the law and what approach EU rule-makers will take toward commercial end users.

It was added that there is no doubt that corporate hedging costs may increase if companies are forced to post margins on OTC swap trades, especially if, as some observers fear, US regulators interpret Dodd-Frank requirements as being retroactive to existing trades, as opposed to limited to new transactions.

However, the 65 companies participating in the Greenwich Associates study also predict higher hedging costs even if margins are taken off the table. "Two-thirds of study participants say rules requiring banks and non-bank financial institutions to centrally clear all derivatives transactions will increase their own costs," said Greenwich Associates consultant, Andrew Awad.

"To some extent it's inevitable,” he added. “If banks are forced to lay off their own risks through centrally cleared transactions and are subject to a range of new capital, margin and record-keeping requirements, the additional costs will be passed through to their commercial clients."

However, despite the negative impact on costs, Greenwich Associates finds that companies around the world do expect the shift of derivatives trades to exchanges to generate important benefits. Almost all the participants in the study say central clearing is effective in mitigating counterparty risk.

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