and the CFTC are working jointly on the new
regulations, rules applying to non-bank dealers will likely be paralleled in those for banks.
Although neither Gensler nor other CFTC
staffers have explicitly expressed support for
margin requirements for end users, neither
have they nixed the possibility. “We haven’t
gotten any assurances that regulators will not
apply margining requirements directly on end
users,” says Michael Bopp, co-chair of the
public policy practice group at Gibson Dunn
& Crutcher. The CFTC did not return calls
seeking a comment on its stance on margin
requirements for end users.
Should such requirements be imposed, the
impact on end users could be significant. In a
panel discussion following Gensler’s presentation, Tammy Evans, director of global funding
for investments and foreign exchange at IBM,
said the notional value of IBM’s derivatives
portfolio at the end of the second quarter was
between $40 billion and $45 billion. “
Depending on where the market shifts, you could potentially have upwards of $5 billion in capital
that’s held up in margin requirements,” Evans
said, adding that for IBM, that equates to a
year’s worth of acquisitions.
Deas notes that a Business Roundtable
study estimated its members would have to
hold $269 million, on average, to meet margin
requirements, impeding their investment in
plant and equipment and research and development. “We’ve extended that estimate to the
S&P 500, and that effect would result in the
loss of 120,000 to 125,000 jobs,” he says.
The challenge of putting in place the systems and staff to handle margin requirements
could discourage some companies from using
derivatives.
“We’re neither staffed for nor do we have the
systems to accommodate the kind of daily, and
perhaps intraday, mark-to-market analysis that
would be required in order to post margin,”
says Eastman’s Hall, adding that such new re-
quirements would “probably preclude us from
participating in the [derivatives] market.”
The CFTC, the Securities and Exchange Com-
mission and banking regulators are on a tight
schedule to finish the multitude of new rules
stemming from Dodd-Frank, which mandates
such regulations be in place within 360 days of
the bill’s signing. If CFTC officials do not clarify
the margin issue soon, corporations will see
the agency’s intent in black and white when it
issues draft rules for public comment, expected
in November or December.
Even if corporate end users are not subject to
margin requirements, imposing those requirements on dealers will most likely make using
OTC derivatives more costly for end users.
Sam Peterson, a senior adviser in Chatham
Financial’s regulatory advisory services group,
says Chatham analyzed the impact of requiring
a bank dealer to post 2.5% initial margin and
full-variation margin on a 10-year, $100 million
notional interest-rate swap.
The Kennett Square, Pa., derivatives adviser
and technology provider estimates it would
cost the bank $1 million over the 10 years.
“That’s not to say all of that cost would be
passed on to end users,” Peterson says. “But
even if it’s 10%, that $100,000 is important to a
commercial end user.”
The extent to which costs rise for end users
will depend on how regulators define the cat-
egories laid out in Dodd-Frank. For example,
the law divides OTC derivatives users into four
types: swap dealers, major swap participants
(MSPs), financial entities and nonfinancial end
users. The first two will be highly regulated; the
What we’re all
waking up to
is a back door
to margining.
—NaCT’S deaS
latter two to a lesser degree.
Nonfinancial firms making markets in OTC
derivatives could be labeled dealers, while
other companies with enough derivatives on
their books to pose systemic risk would be labeled MSPs, Peterson says. Nonfinancials potentially in the dealer category—mainly large
energy companies—are probably already anticipating the new requirements. Dodd-Frank
mandates that dealers centrally clear their OTC
derivatives trades, or trade certain derivatives
over an exchange or yet-to-be-developed swap
execution facilities, and it also imposes a slew
of business conduct, record-keeping and reporting rules.
MSPs will face the same rules as dealers,
but it’s much less clear which companies will
fall into that category. Peterson says some
nonfinancial end users may be labeled MSPs if
they have very large volumes of swaps on their
books. Dodd-Frank creates a link between the
MSP category and a company’s potential to
pose systemic risk, he says, but adds, “We don’t
know where they will draw that line.”
Gibson Dunn’s Bopp says that no regulator
has recommended a limit yet, but $50 billion
in notional value has been discussed as the
threshold over which a company could be
considered systemically significant.
Deas points out two important distinctions
between the U.S. and the EU’s regulation of
OTC derivatives. First, the EU clearly links
central clearing and margining. If an end
user is exempt from clearing, it is also exempt
from margining. Under Dodd-Frank, however,
while all end users are exempt from central
clearing, some—as Gensler has suggested—
may have to post cash collateral as margin for
their derivative positions.
Second, in the EU, an end user’s hedging
of underlying business exposures with OTC
derivatives does not count in measuring the
level of derivatives activity that triggers additional regulation. Instead, the EU will consider only what is left over after the derivatives
and underlying exposures are netted, and the
systemic risk that poses, an approach supported by NACT and the Coalition for Derivatives End-Users.
The EU regulators have set two thresholds,
based on a netted number, that apply to all
market participants. Breaching the first “
information threshold” will require reporting
