Latest Margin Proposal Riles End Users


It's confirmed: U.S. banking regulators want companies that use over-the-counter swaps to post margin, at least those nonfinancial firms deemed riskier credits by their bank counterparties.

Five federal banking regulators issued a proposal Tuesday that would require nonfinancial companies to post margin on swap transactions if the net market value of their positions exceeds thresholds determined by their bank counterparties' normal credit processes. Companies with riskier credit profiles would face lower thresholds and vice versa.

A separate proposal from the Commodity Futures Trading Commission, also announced yesterday, would not require the swap dealers it regulates to develop thresholds for corporate customers. However, the CFTC's jurisdiction is limited to nonfinancial swaps dealers, such as energy companies.

The banking regulators--the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., the Farm Credit Administration and the Federal Housing Finance Agency--regulate financial institutions. Companies that use swaps typically hedge currency, interest-rate and other risks with banking institutions, and regulators are concerned those financial institutions pose greater systemic risk.

The Dodd-Frank Act enacted last summer exempted corporate end-users from having to clear OTC swaps, and many companies assumed that meant they were also exempt from margin or cash collateral requirements. As a result, they view the banking regulators' proposal as a back-door attempt to impose margin requirements. That's especially true given that the congressional authors of the Dodd-Frank exemption specifically noted that corporates were to be exempted.

Nevertheless, by giving bank counterparties the authorization to determine the thresholds, banking regulators clearly recognized that corporate end users pose far less of a systemic risk than financial institutions. However, corporate users still have concerns, says Luke Zubrod, director at Chatham Financial.

Zubrod notes that using their supervisory authority, regulators could judge--especially during periods of market stress--that a bank-determined threshold is inappropriate given the credit risk of the corporate customer. That could effectively give regulators veto power over a bank's threshold decisions, potentially lowering the threshold the bank places on a customer and increasing the customer's margin requirements.

"We have a lot of questions about how regulators might insert themselves into this process," Zubrod says.

Financial end users of swaps, likely including pension plans, face much stricter margin requirements than nonfinancial companies. High-risk financial end users would be required to collateralize the full value of a transaction or portfolio of transactions, including the variation margin to cover the derivatives' changing market value and the initial margin providing a buffer above and beyond the market value.

Low-risk financial end users, which potentially include community banks, would post margin when the net market value of their derivative portfolios is higher than the relatively low threshold of approximately $30 million set by the regulators.

"One of our clients owns a single building in New York City, and the value of its position on the derivative used to hedge the debt on that building has been as high as $180 million," Zubrod says.


For more on this issue, see CFTC Eases Swaps Concerns.

Comments