The Calm Before Reform

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

At his own company, Kasok says, an increase of just 2 basis points in the cost of his foreign-exchange hedging program would cost his company $500,000 (or the equivalent of nearly one cent per share when Millipore was publicly traded). “This is real money,” he says, “and could easily equate to three to five jobs.”

While Kasok says it’s hard to say whether those jobs would actually be cut, “at an absolute minimum it takes that amount of earnings away from our shareholders and moves it to the financial institution and the newly created swaps intermediary.”

Unintended Consequences

Many financial executives also worry how the law of unintended consequences will intersect with the new laws of Wall Street. There has already been one eyebrow-raising mash-up. Shortly after President Obama signed the Dodd-Frank Act into law on July 21, the three major credit-rating agencies, citing concerns about the more stringent liability standards they face under Dodd-Frank, briefly refused to allow issuers of asset-backed securities to include their ratings in their offering documents as has long been required by law. Their sudden pullback shut down the ABS market until the Securities and Exchange Commission granted ABS issuers a six-month period to issue new securities without including credit ratings in their offering documents, while giving the agencies that time to adjust to the new Dodd-Frank liability standards.

Other potential hazards loom. For example, to reduce systemic risk to the financial markets, Dodd-Frank’s “Volcker Rule” restricts banks to committing no more than 3% of their Tier-1 capital to proprietary trading. To the extent that that reduces bank participation in the derivatives markets, finance executives say, it could reduce liquidity and so drive up costs.

That is actually not all bad in the view of Millipore’s Kasok, who says he would happily give up some liquidity if it reduced market volatility attributable to speculative trading. At the same time, he concedes that it is hard to know just how much of the market’s liquidity speculators have been responsible for. That makes it hard to forecast the impact their reduced participation would have in the marketplace.

Ian Cuillerier, a partner in the structured finance and derivatives practice at White & Case, also questions whether increased transparency in the derivatives market might make it more expensive for banks — and hence their clients — to execute very large derivatives transactions. The problem could arise, he explains, if a bank clears a large trade with a corporate end-user and then, as potentially required under Dodd-Frank, immediately reports the details of that transaction to the marketplace. Typically, the bank will hedge its own risk on that trade by entering into a second transaction with another counterparty. Having been apprised of the first deal, Cuillerier says, other market makers might drive up the bank’s costs on the second transaction.

Whether this will happen depends to a large degree on how regulators write the rules enforcing Dodd-Frank. There has been discussion, for example, about exempting large trades from real-time reporting requirements. The act gives regulators a year to come up with the rules, and it is widely expected that they will release a large number for comment over the next three months.


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