Regulators are expected to crank up output of Dodd-Frank Actrules in the months ahead, leaving corporate end users ofderivatives waiting to see how the regulations will affect theiruse of over-the-counter swaps.

Two of the most controversial issues that regulators willtackle—whether end users will have to post margin and whether theirinter-affiliate swaps will be exempted from new requirements—mayalso be addressed by Congress. In late July, Rep. Michael Grimm(R-NY) introduced legislation that seeks to clarify that swap endusers are exempt from margin requirements. And Rep. Steve Stivers(R-OH) introduced a bill in August that would ensure that companiesusing swaps internally among affiliates were exempted fromDodd-Frank rules.

Pat Ryder, director of financial risk management at EastmanChemical, says his company fought hard for the end-user exemptionfrom margin requirements when the Dodd-Frank legislation was beingwritten. The exemption was included in the legislation, along withan exemption from clearing the transactions. Since the legislationbecame law, however, the FDIC has proposed giving prudentialregulators the authority to require banks to post margin on swapsand collect margin from their clients.

Whether regulators ultimately approve that back door approach tomargining is something end users will be watching.

“Our first concern is margining, tying up that cash and settingup the infrastructure to monitor positions” and put up margin ifappropriate, Ryder says, adding that currently Eastman has nomargining obligations.

Companies use inter-affiliate swaps to balance their books,often to net out their exposures to more efficiently hedge theirrisk, says Tom Deas, treasurer and vice president at FMC Corp. andpresident of the National Association of Corporate Treasurers(NACT). Regulators, however, have suggested companies must reportthose transactions to still-to-be-built swap data repositories inreal-time.

NACT has supported more transparency and suggested that banks,which already have the necessary back-office systems, report theswap transactions they engage in with corporate customers, Deassays. Inter-affiliate swaps are not market transactions, however,and unlike banks acting as swap counterparties as a business,companies typically lack the systems to report the data. “We don'thave the back-office systems in place to fulfill this requirement,”Deas says.

Jiro Okochi, CEO and co-founder of Reval, a provider offinancial risk management solutions, says that if marginrequirements and the documentation rules are imposed on companies,banks and other dealers will require corporate customers to enterinto credit support annexes (CSAs), which legally regulatebilateral swap agreements. Most swap market participants use theInternational Swaps and Derivatives Association's CSA template. Butcompanies must be sure their law firms are familiar withnegotiating CSAs, Okochi said, and they should make sure they getin the documentation queue with banks sooner rather than later,since if the requirement is put in place, banks may becomebacklogged.

Both Deas and Ryder say their companies are waiting for furtherdevelopments before tackling the CSA issue.

The regulators' swaps proposal would establish thresholds,around which counterparties would shift collateral back and forth,depending on the values of the swap sides. Companies that have puton hundreds of swaps with a dealer may have to reconcile valuationsas often as daily. Firms such as Reval and Chatham Financialprovide automated swap valuation services, but that's an additionalcost.

Ryder says Eastman has the technology and processes in place todo daily valuations. However, the company doesn't want to “shipcash” when it holds the “exact opposite physical position” the swapis hedging, he says, adding that Eastman would have to develop theability to monitor positions and determine when to pay or collectmargin.

In addition, margin requirements would force companies to setaside cash to ensure they can meet margin calls when theyarise.

“If a corporate treasury is called to meet margin requirementsand it doesn't, then it's in default. So we would have to holdcredit to meet that potential margin call,” Deas says. “Holdingaside that amount of credit, with a cushion required [to coverunexpected margin calls], would be a significant subtraction fromthe credit we use to run our business.”

A study undertaken by the Coalition for Derivatives End-Usersestimated that the average nonfinancial member of the BusinessRoundtable would have $120 million of cash or committed credit tiedup to meet daily derivatives margin requirements.

For a discussion of the CBOE's exchange-traded CDS, seeCredit Default Swaps Makeover. And for a look at possiblechanges to hedge accounting, see Hedging Inflation and Other Risks.