Corporate end users of swaps are breathing easier after the Commodity Futures Trading Commission (CFTC) earlier this month proposed definitions to categorize swap users that are unlikely to affect companies using swaps to hedge commercial risk. However, other concerns remain for companies, such as the CFTC's contention that it has the authority to impose margin requirements directly on end users.
Currently, corporate end users don't post margin on swap transactions they use to hedge or mitigate business risks related to changing interest- and foreign-currency rates, commodity prices and other factors. The Dodd-Frank financial reform legislation creates a new category of swap users, called major swap participants (MSPs), that will be subject to margin requirements and regulations similar to those imposed on swap dealers, and end users worried they could fall into that category.
The CFTC proposal sets two thresholds for determining MSP status: companies with $5 billion in current uncollateralized exposure and with $8 billion in current uncollateralized exposure plus potential future exposure.
Sam Peterson, a senior adviser in Chatham Financial's regulatory advisory services group, says most of his firm's customers will not exceed those thresholds.
The threshold calculation requires companies to multiply the notional value of their swaps by pre-determined risk-factor percentages based on the types of swaps and the duration of the positions, then apply discounts based on netting and collateral held against those exposures.
Peterson says the CFTC and the Securities and Exchange Commission clearly incorporated public feedback when crafting the definitions.
"The fact that [the calculation] allows for netting, and essentially subtracts the collateral posted for the swap exposures is helpful," says Peterson, whose firm has worked closely on the issue with the Coalition of Derivatives End-Users, an umbrella group that includes Financial Executives International, the National Association of Corporate Treasurers (NACT), the U.S. Chamber of Commerce and several other corporate trade organizations.
Thomas Deas, president of NACT and treasurer at FMC Corp., praised regulators' broader definition of commercial risk in the proposal, since end-user swaps meeting the definition won't have to go through a clearinghouse.
"Many manufacturers are subject to indirect risks such as fuel cost adjustments from shipping companies, and the definition of commercial risk would be broad enough to allow them to hedge that risk," Deas says.
There are still some outstanding issues keeping end users on edge, however. For one, notes Deas, it remains unclear whether regulators will consider foreign-exchange forward transactions as derivatives, a decision the Treasury Department is likely to make next year. And in cases where a company nets multiple swaps internally before engaging a dealer, regulators must decide whether to count the separate swaps or the netted amount. Adverse decisions on either issue could push some companies into MSP territory.
Another issue is whether the regulators can impose margin requirements directly on nonfinancial companies that use swaps. CFTC Chairman Gary Gensler has said he believes they can, although during a Dec. 1 open meeting he suggested he would not use such authority. The Federal Reserve oversees the bank dealers that are typically the swap counterparties of corporate end users, so its decision on the issue is more relevant. Sources say Fed officials have discussed imposing lesser margin requirements on corporations than MSPs or dealers would face.
Last week, 11 organizations representing the financial services industry, including the Securities Industry and Financial Markets Association, the American Bankers Association and the Futures Industry Association, sent a comment letter to both the SEC and the CFTC asking regulators to slow the pace of their work on derivatives regulations to allow firms more time to comment on proposed rules and comply with all the new rules that are to be imposed.
For more on companies' concerns about swaps regulations, see Corporate End Users in Jeopardy.