High capital charges on uncleared OTC derivatives could spur dealers to offer companies some attractive incentives.
Bank relationship management is about to get a lot more interesting. The corporate exemption from Dodd-Frank’s requirement that derivatives be centrally cleared will allow treasurers to continue to trade bilaterally with their dealers. But bankers working to build up their firms’ clearing operations in anticipation of Dodd-Frank implementation expect to see a fair bit of corporate activity nonetheless.
That’s surprising, considering all the lobbying corporates did during the law’s gestation about how initial and maintenance margin would siphon away precious capital. If the S&P 500’s constituent companies had to pay a 3 percent margin on their OTC derivatives, it would reduce their capital spending by nearly $7bn a year, leading to a loss of 130,000 jobs, shrieked the Coalition for Derivatives End-Users in a report last February.
So, having won that fight (a victory their European counterparts would also like to achieve), why would corporates go through clearinghouses? Bankers say its because the punitive capital charge that will be levied on dealers’ uncleared OTC derivatives trades will spur them to offer their corporate clients some incentives. They could cut the pricing of certain transactions if treasurers agree to clear them, or offer some other type of compensation for the margin costs corporates would bear.
“We’re not talking about a toy in a happy meal here,” says one banker. “We’re looking at changing the whole economics of the transaction to favor clients.”
Of course, how much bankers concede on pricing will depend on the capital charge that regulators eventually decide to levy on OTC trades. But since that charge is meant to act as a disincentive to those transactions, it is sure to be uncomfortably high. Also, there’s a limit to how much dealers could cut pricing. After all, greater transparency is expected to cause some significant spread compression.
Comments in a June speech by Federal Reserve Board Governor Daniel Tarullo supporting a SIFI capital level up to 7 percentage points above Basel III’s 7 percent maximum show that support for sky-high capital levels exists among important regulators (see related story here). That’s bad for lenders, but it if OTC capital rules reflect some of that thinking, it could be good for corporates.