What goes around comes around. US regulators have interpreted the Dodd-Frank Act to require them to push US swap regulations aggressively across borders. And while their proposed margin requirements are expected soon, the European Union is collecting comments on a proposal to slap margin requirements on any nonfinancial end user using European counterparties.
Comment letters on the EU’s proposal are due July 14. It would require EU entities “to collect margin from all third‐country entities … even from those that would be classified as non-financial entities below the threshold if they were established in the EU,” the consultation says.
Officials at the US prudential regulators, who will jointly issue the proposal, have stated on numerous occasions that their interpretation of the financial reform legislation, signed into law in July 2010, requires them to impose margin on nonfinancial end-users, although they are not opposed to a new law that exempts corporates from margin. Indications so far suggest the proposal would require banks to establish thresholds for each counterparty, and margin would have to be posted on both sides when the exposure exceeds the threshold.
“The US would require banks to establish a threshold for even the smallest amount of exposure, and the threshold would need to be appropriate for the credit risk of that corporate,” said Luke Zubrod, director at Chatham Financial.
The EU, instead, has established a single threshold of EUR 8 billion—an amount considered tied to systemic risk—and that is likely to ensnare far fewer corporate derivative users. However, all non-EU, nonfinancial corporate end users engaging in swaps with European counterparties would have to post initial margin as well as the variation margin all participants must post.
“If a U.S. end user wants to transact with a European bank, that US end user will be required to collateralize the transaction fully. Whereas European end users would be exempted,” Mr. Zubrod said.
Whether that severe requirement makes it into a final rule, however, is open to question. Zubrod called it “patently irrational” because U.S. end users would be driven away from the European swap market, resulting in a fragmented market. To some degree, that’s already happened, as very large European financial institutions such as APG Asset Management, which manages the pension assets of 4.5 million Dutch citizens, have said they now avoid using U.S. institutions as swap counterparties, to avoid being swept into Dodd-Frank rules.
Mr. Zubrod noted the somewhat contentious relationship that has developed between U.S. and European regulators as financial reform unfolds on either side of the Atlantic, especially with regard to the treatment of cross border swaps.
“My guess is European policy makers included this in the proposal as a part of the cross-border chess match,” Mr. Zubrod said. “It would create concern among U.S. policy makers and give the EU leverage in cross border negotiations.”