From the November 2010 issue of Treasury & Risk magazine

Corporate End Users in Jeopardy

As a global company, Eastman Chemical's earnings can be impacted significantly by swings in interest and foreign exchange rates, as well as in the prices of commodities, especially natural gas and propane. To mitigate that volatility, the $5 billion manufacturer of chemicals and plastics projects its propane needs, for example, over the coming year and purchases the commodity using forward contracts to lock in a price over that period. That allows executives figuring out their budgets for the next year to more effectively price products and analyze profitability.

"By taking some of the volatility out of the price of raw materials, we're able to provide customers with some pricing certainty so they can better manage their businesses," says Mary Hall, treasurer and vice president of Eastman Chemical. "Without derivatives, we wouldn't be able to do that."

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.

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 marked-to-market positions to the regulators, while crossing the "clearing threshold" will require centrally clearing the transactions.

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