The Calm Before Reform

With sweeping new legislation on the horizon, companies (and their banks) try to gauge the impact.

“If somebody doesn’t have to pay all the costs of supervision, doesn’t have to maintain all the capital, doesn’t have to have reserves with the Fed and all these other things, you have to ask yourself whether they might have an advantage and can offer lower borrowing rates,” Patrikis says.

Spotlight on Derivatives

Beyond the general availability and cost of credit, the Dodd-Frank Act promises to bring dramatic change to the over-the-counter derivatives market, which for the first time will be subject to government regulation. Among the most sweeping reforms is a requirement that most plain-vanilla derivatives — “standardized,” in the language of the legislation — be traded on an exchange or similar “swap execution facility.”

Where that is not possible, over-the-counter derivatives will have to be cleared through a regulated clearing organization, if such an organization will accept them. Finally, where that doesn’t happen, trades will have to be reported to a central data repository and higher capital and margin requirements may be imposed on dealers and what the legislation refers to as “major swap participants.”

The overall goal is to provide greater transparency to the derivatives market and reduce systemic risk. Proponents argue that the changes also will improve liquidity in derivatives markets and reduce hedging costs for corporate end-users.

Many finance executives aren’t so optimistic. They note that contracts traded on an exchange or cleared in some fashion typically require buyers and sellers to post margin against their positions daily. “If treasurers have to tie up millions of dollars a day in margin, that’s money they’re not using to hire workers, or to invest in R&D or new technology,” says Cady North, senior manager of government affairs for Financial Executives International (FEI), an association for senior finance executives. Some observers suggest the new law may drive derivatives trading overseas.

It is still possible that regulators will exempt most corporate end-users from posting margin; preconference versions of the act actually provided for this. The version signed into law, however, includes only a limited end-user exemption, and North warns that even if end-users are exempted it won’t necessarily nullify the margin issue. There is a concern that major swap dealers will pass costs on to customers if they are not granted some kind of exemption.

“Costs may go so high that it becomes prohibitive for companies to enter into these contracts,” North says. The result could be that “they won’t manage risks such as currency fluctuations, or they may have trouble growing or moving money around on a regional basis or purchasing equipment in one country and bringing it into another.”

Steven Kasok, treasurer of Millipore Corp., a $1.7 billion U.S. unit of German pharmaceutical and chemical company Merck KGaA, doesn’t expect corporations to stop hedging their risks, but he is worried that it will cost them more. Banks saddled with new regulatory costs, from higher reserving requirements to clearing fees, will likely pass those costs on to their customers, he says.


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