Higher Swaps Costs Still Likely

Regulators clear up some uncertainty, but more rules yet to come.

Regulators’ tighter definitions for determining which companies must register as swap dealers and major swap participants should come as a relief to many large corporations, but the cost to hedge risky exposures using swaps is nevertheless likely to rise for most end users.

The rules approved by the Securities and Exchange Commission and the Commodities Futures Trading Commission on Wednesday ramped up the threshold at which a company is required to register as a highly regulated swap dealer to $8 billion in notional value of swaps generated annually, up from $100 million in the proposal. That threshold—only for swaps not used as hedges—drops to $3 billion within five years unless regulators opt for a different level.

Two of the three prongs in the definition of a major swap participant (MSP) exclude swaps used for hedges and so wouldn’t impact corporate end users at all. The third prong, which tallies hedging and nonhedging exposures, could impact end users, but market participants must exceed a current exposure threshold of $5 billion.

A counterparty’s exposure is typically a small fraction of the swap’s notional, or face, value and that should mean only the very largest swap end users have to register as MSPs. Luke Zubrod, director of Chatham Financial’s regulatory advisory service, notes that an “important feature of the MSP definition is that it nets collateral when determining the size of positions against those thresholds.”

Tom Deas, treasurer and vice president at FMC Corp. and chairman of the National Association of Corporate Treasurers (NACT), adds that cleared transactions in which counterparties put up collateral do not count toward the thresholds, giving companies a “lever” to control whether they’re tagged as MSPs or swap dealers. Deas says, though, that there’s still uncertainty about the definition of hedges, which are also excluded from the threshold tally.

“The hedging definition [in the rule] talks about physical delivery, so we’re uncertain about whether that applies only to derivatives like commodity swaps,” he says. Deas adds there’s similar uncertainty about non-deliverable forwards, which are commonly used to hedge currencies that are subject to foreign-exchange controls, such as the Chinese renminbi.

The more than 1,500 swap-related rules stemming from the Dodd-Frank Act are expected to increase swap dealers’ compliance costs. Institutions whose swap activity falls below the thresholds, mainly regional banks, will not face that hurdle.

“The biggest sigh of relief is from smaller corporates that couldn’t get swap lines with the big global banks,” says Jiro Okochi, CEO and founder of Reval. He adds that those companies worried their swap-market liquidity would dry up if their banks deemed compliance costs excessive.

Deas says it’s not likely banks that fall below the swap-dealer threshold would pick up much new business on the promise of lower costs, since companies typically engage in swaps with their main lenders and would probably swallow any marginal cost increases. However, regulators have yet to finalize other Dodd-Frank-related rules that are critical to the cost of the over-the-counter (OTC) swaps favored by corporate end users. It’s not clear whether registered swap dealers will be required to impose margin on end users or the extent of new capital requirements on banks’ OTC swap positions, the cost of which in turn would be passed on to end users. Both decisions are expected in the second half of the year.

“These recent definitions clear up some of the uncertainty, but it could prove to be a Pyrrhic victory,” Deas says, since depending on upcoming decisions, “the costs for uncleared trades may increase to the point where they are no longer economic.”



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