The corporate end-user exemption to the Dodd-Frank bill's tough new requirements for trading over-the-counter derivatives has survived a torturous, contentious legislative process. The principle of exempting corporate hedgers from provisions meant to reduce systemic risk caused by dealers and speculators is embedded in the landmark financial reform bill that teeters on the brink of passage. "The exemption is in place," reports Brian Kalish, finance practice lead at the Association for Financial Professionals. "We're comfortable."
While that paper exemption is comforting, it may not protect corporate treasuries from the market fallout as banks, dealers and speculators that are not exempt change their business strategies. "Even if we're exempt," notes Pat Ryder, director of financial risk management at $5 billion Eastman Chemical in Kingsport, Tenn., "we may still get hit with higher costs through the bid-ask spread and maybe have to post margin to the banks through enhanced credit support annexes. Our cost may go up."
"The devil is in the details," observes Jiro Okochi, CEO of Reval, a New York City-based derivative risk management and hedge accounting software firm. "On paper, some things are settled. In practice, we have to wait and see. There will be studies and rule-making, but the intent is to not force nonfinancial corporate end users onto exchanges or into clearing." If players don't like the rules, they will abandon certain markets or derivatives, which will die a quick death, Okochi adds.
Some last-minute drama occurred when close readers discovered that language in the bill exempting corporate end users from certain capital and margining requirements applied to swap dealers had disappeared in the conference committee's draft, prompting the National Association of Corporate Treasurers (NACT) to send out a letter urging treasurers to ask their legislators to restore that language.
"There had been a clear exemption from margining for end users in the bill, but that disappeared during an all-night negotiating session just before the bill was reported out," says Tom Deas, president of NACT and treasurer and vice president at $3 billion FMC Corp., a Philadelphia chemicals company. "Without that language, there could be a $1 trillion cost to corporate end users, an unintended but real consequence."
To Okochi, an astute and attentive watcher of OTC derivatives legislative developments, the deletion of the exemption from capital and margining requirements was no big deal, just a trimming of redundant language that preserved the exemption. "They tidied up the language to make it clear that the trade done with end users is exempt, not just a counterparty," so both counterparties get the benefit of the exemption, he says.
Currency derivatives were exempted in the House bill but are not exempted in the conference committee draft, which would leave the rules on trading currency derivatives up to regulators. "If the conference committee draft is passed, it will give a lot of power to the regulators to set the rules," says Eastman Chemical's Ryder. The bill does allow for the Treasury Secretary to make a written case to re-exempt foreign exchange swaps and foreign exchange forwards.
The biggest changes will fall on the banks, Ryder points out. Depending on the type of derivatives, banks may be able to trade them within the FDIC-insured entity, or they may have to trade them from a separately capitalized, uninsured subsidiary. Much of the legislation's impact on banks and dealers won't be felt until 2013, 2014 or 2015, he adds, because delayed effective dates give them time to adapt.
Of course, the effects of the legislation may not be felt at all if the Senate can't find the 60th vote needed to pass it, given that West Virginia Democrat Robert Byrd died before final floor action. Meanwhile, the European Commission comment period ended July 10, leaving the EC on the brink of adopting its own rules around derivatives clearing, which may or may not mirror the Dodd-Frank bill, which may or may not find that critical vote.