No news may be good news on the swap margin front, as two bills—one ensuring swap margin requirements aren’t imposed on corporate end users and the other exempting inter-affiliate swap transactions from being treated like market-facing trades—move through committee toward a House vote. Banking regulators and the Commodity Futures Trading Commission last April proposed imposing swap margin requirements on swap dealers, major swap participants and other financial entities.
They explicitly said that the regulations would not be imposed on nonfinancial end users, but financial institutions would be permitted to impose margin requirements on their clients.
That’s raised a ruckus among derivatives end users, which see the language as a back-door attempt to impose margin requirements on them, even though the rules’ authors have said that was not the intent.
In addition to having to implement systems to monitor swap values and post margin when appropriate, the proposed requirement could remove a significant amount of capital from productive use. The Coalition for Derivatives End-Users submitted a letter to the House Committee on Agriculture in January citing a survey that estimated the proposed rule could require S&P 500 companies alone to post as much as $6.7 billion in margin, costing 100,000 jobs or more.
Chatham Financial has worked closely with regulators and end users on the issue, and Luke Zubrod, director of the firm’s derivatives regulatory advisory service, says a decision from U.S. regulators isn’t likely until at least June. Zubrod notes that the Group of Twenty finance ministers and central bank governors established a working group in November, comprising representatives from the International Organization of Securities Commissions and the Basel Committee on Banking Supervision, to develop a proposal for swap standards to be issued in June.
“From what we gather, U.S. regulators are likely to pause to let this international process play out a bit, so we don’t currently anticipate a final margin rule from the banking regulators until after the June meeting,” Zubrod says. He added that Singapore’s regulator noted Feb. 13 in a derivatives consultation document that it will consider the working group’s proposal in its own swap margin deliberations.
The delay doesn’t guarantee U.S. regulators will join a global effort to create swaps standards, which may or may not include margin requirements. However, uniform rules most likely would make it easier for the treasury departments of multinationals to use swaps from compliance and administrative perspectives. And a lack of uniformity could create market distortions.
“Counterparties vary across geographies as well as the credit spectrum,” notes a treasury executive at the finance arm of a major automobile manufacturer. “Without consistent standards, transaction flow will move to those jurisdictions and counterparties where cost and liquidity are most advantageous.”
The intent of recent regulation has been to reduce systemic risk to the financial markets, the executive points out. “As we were reminded during the last credit crisis, financial markets are global, and as such, any attempt to address the risks associated with the markets should be constructed from a global perspective.”
Ambiguity continues on how to treat inter-affiliate swaps. End users say that trades between affiliated parties do not pose a systemic risk and also note that their systems are not set up to report those transactions to the swap data repositories established by the Dodd-Frank Act. Zubrod says regulators have indicated they will provide guidance, but it’s not clear when.
In the meantime, efforts to protect end users are proceeding on the legislative front. The Stivers-Fudge bill, H.R. 2779, which exempts inter-affiliate trades from requirements applied to market-facing swaps, and the Grimm-Peters-Scott-Owens Business Risk Mitigation and Stabilization Act of, 2011, H.R. 2682, which ensures nonfinancial end users would never face margin requirements, passed out of subcommittee in January.
The two bills must be merged before being voted on by the full House. No comparable bills have been introduced in the Senate, however, which means the House legislation may mostly serve as a lever to encourage regulators to soften their proposals.