MarketView for April 12

Some Are Exempt from Swap Rules

 Companies would be largely spared from increases in the costs of using derivatives when they hedge against price fluctuations, under regulatory proposals issued on Tuesday. Power companies, airlines and major manufacturers feared that regulators would force them to post collateral, or margin, with a bank when they hedge against risks such as changes in currencies, fuel costs or interest rates -- raising the cost of using swaps to lock in profits.

The proposals, issued by Commodity Futures Trading Commission and the Federal Deposit Insurance Corp for public comment, craft margin exemptions for the small slice of the derivatives market in which companies need highly customized swaps that can't be cleared through exchanges.

The proposals are part of last year's Dodd-Frank reform law aimed at curbing swap speculation of the sort that amplified the devastating 2007-2009 financial crisis, while still letting businesses hedge their risks.

However, there were sufficient differences between the CFTC's plan and the one issued by the FDIC and other banking regulators, to keep some companies guessing about whether they will be fully exempt from having to post margin when using derivatives.

"I believe commercial end-users and many of the financial end-users will be dissatisfied with the lack of harmonization among the different regulatory bodies," CFTC Commissioner Scott O'Malia said before dissenting in the agency's 4-1 vote to seek public comment. The CFTC's proposal applies to non-bank swap dealers and offers a clear margin exemption for corporations hedging their business risks.

The bank regulators' proposal applies to banks such as JPMorgan and Bank of America that serve as swap dealers, and does not offer a clear exemption for end users. The latter proposal could force a corporation to post collateral if the bank selling a derivative found that the corporation was too much of a credit risk.

It is unclear how often banks would have to demand collateral from corporations, but the lack of a clear exemption drew ire from business groups.

"Despite the clear legislative history to the contrary, the regulators continue to misinterpret the Dodd-Frank Act as giving them authority to impose margin requirements on end-users," said a statement from the Coalition for Derivatives End-Users, an industry group.

Profits hang in the balance not only for corporate end-users, but also for the big financial companies that dominate the swaps market, including Citigroup, Goldman Sachs and HSBC. They could be hurt if they can no longer offer margin-free swap trades to corporations. Nearly a third of all off-exchange derivatives trades last year were not secured by collateral, or margin, said the International Swaps and Derivatives Association.

Companies have argued for a generous exemption because they use derivatives solely to hedge risk. They insist they are not at risk of destabilizing the financial system, and have trumpeted the potential for higher costs. The proposals affect businesses as diverse as Constellation Energy, MillerCoors and Caterpillar -- all of which use swaps to manage risk.

One study estimated that a 3 percent margin requirement on swaps used by Standard & Poor's 500 companies could cut capital spending by as much as $6.7 billion. The FDIC said the bank regulators' proposal would have minimal impact on corporations hedging business risk.

"We should not impose an undue burden on the vast majority of the market participants that really did not play a role in the financial crisis," FDIC Chairman Sheila Bair said.

CFTC Chairman Gary Gensler said his agency and bank regulators aligned their rules "to the maximum extent practicable."

The CFTC, which polices derivatives markets, and the FDIC, which regulates banks, are working on implementing scores of post-crisis regulations, including the swaps measures, mandated by 2010's Dodd-Frank. The agencies' proposals will be issued for public comment for about 60 days. Between now and then, the agencies will come under pressure to make modifications.

The difference in the bank regulators' and the CFTC's approaches may hit the banks, which could be forced to demand margin from corporations, compared with non-bank swap dealers such as Shell and Cargill, which could offer margin-free trading for certain swaps.

The bank regulators' proposal will give banks two options for determining whether they need to demand that corporations post margin on un-cleared swap trades. The first option is to use a standard table that regulators will create. The second would be based on how much the trade could be affected over 10 days under stress.