NACT seeks resolutions on outstanding swap and MMF Issues
Corporate end users avoided the costly swap margin requirements that most of the financial community will face later this year, but when was the last time Wall Street sucked up higher costs and didn’t pass them on to clients?
That will be the general theme from 10,000 feet of a report that the National Association of Corporate Treasurers (NACT) is helping craft to quantify the impact of margin requirements on bank counterparties and ultimately their corporate clients. Thomas Deas, past chairman of NACT and its lead voice on regulatory issues, called the margin issue the “next big new thing” impacting corporate end users.
“Although we were able to get an exemption from nonfinancial companies from posting margin, if that same economic cost comes through in wider spreads on derivatives from banks, then the same bad effects will befall us,” Mr. Deas said in a recent interview.
Active since the 1980s, the NACT tended to avoid advocacy issues since its members represent a wide variety of industries with different and often conflicting views. That changed with the passage of the Dodd-Frank Act and other legislation emerging from the financial crisis – like money market fund (MMF) reform – which is likely to impact virtually all members adversely.
But recently the NACT has been a leading voice in the US for corporate treasuries, arguing broadly that derivative end users’ derivative hedges did not instigate the financial 2008 meltdown but rather reduced risk. Therefore corporate users should not incur a collateral penalty. The NACT along with other members of the Coalition of Derivatives End Users conducted a survey in 2014 that found margin requirements would impact the capital expenditures of more than two thirds of multinational corporation (MNC) respondents.
The average respondent would have to set aside $659.9 million of cash or committed credit, capital that could otherwise be used to grow the business, according to the survey, and 44% said they would hedge less while 42% indicated they would use different hedging products or change the structure of hedges.
“Respondents also tell us that a margin requirement would curtail job creation, R&D, acquisitions, and business investment,” the Coalition’s survey report said.
The US Congress ended up passing legislation exempting corporate end users from margin at the end of 2014, around the same time legislation supported by NACT and the Coalition was passed to clarify that corporate end users’ swap transactions between affiliates are also exempt from clearing.
Higher costs to engage in derivatives due to new margin requirements imposed on bank counterparties should adversely impact corporates similarly, and now the NACT and other Coalition members are actively seeking to quantify that impact on corporate end users’ day-to-day business. The ultimate goal would be to relieve banks from margin requirements on swap transactions with end user counterparties.
“By way of contrast, European regulators have determined that end-user derivatives are risk reducing, so they have exempted [counterparties] from the higher reserve requirements,” Mr. Deas said.
Reporting requirements
Another current issue was highlighted by the NACT and the Coalition in January of this year when the group sent a letter to Jonathan Hill, commissioner of financial stability, financial services and capital markets union at the European Commission (EC). In the letter, the two organizations voice concerns about the EC’s swap reporting requirements both financial institutions and their corporate end user counterparties must follow. It further notes that corporate end users represent 76% of total reporting counterparties under European Market Infrastructure Regulation (EMIR) but only 2% of the total notional amount of derivatives reported, and they do not increase systemic risk.
“Dual-sided reporting has created significant initial and ongoing operational, legal and cost burdens for end-user companies,” the letter states. “We urge the Commission to recommend changes to EMIR to exclude intragroup transactions of [nonfinancial corporate end users] from the EMIR reporting obligations.”
The letter was sent as the EC pursues a mandated review of EMIR, which started with a public consultation for which comments were due last August. A report detailing expected changes is anticipated to be published soon. In terms of reporting, the Coalition recommends “single-sided” reporting, in which the data is reported by the banks and relies on straight-through-processing and existing market mechanisms for accuracy – similar to what exists today in the US and most other jurisdictions.
Swap issue
Another issue stemming from the EC’s review mentioned in the Coalition’s letter is regulators recently contemplating the inclusion of swaps used for hedging purposes in clearing threshold calculations. The move would likely require numerous corporate end users to clear swaps that now are over the counter.
“Such a ‘hedging penalty’ would result in ‘real economy’ companies losing clearing and margin exemptions, which would needlessly divert capital and liquidity away from economic growth, resulting in a direct negative impact on job growth in the EU and reduced participation in our markets,” the letter says.
The Coalition and its members have also pushed to harmonize swap regulations in different jurisdictions, especially the US and Europe.
“The lack of regulatory harmonization can cause fragmented and less efficient markets for end-users, and can raise the cost of delivering stable prices to consumers,” testified Mr. Deas in a hearing April 29, 2015, before the U.S. House of Representatives’ Subcommittee on Capital Markets and Government Sponsored Enterprises.
The lack of harmonization issue has persisted for at least three years as regulators in especially the US and Europe have sparred over it. Recently, however, the Coalition’s efforts, along with those of other members of the International Group of Treasury Associations (IGTA), which Mr. Deas also recently chaired, have prompted progress.
Regulators decided in February to deem equivalent each other’s rules related to clearing derivatives, enabling market participants to substitute one set of rules for the other rather than having to comply with both. Although the move doesn’t directly impact corporate swap end users, which are exempt from clearing, it does lessen the likelihood of swap market “balkanization” and the higher costs that implies for all participants. It also represents a significant step on the path to further harmonization.
NACT’s efforts have largely addressed new regulations impacting swaps, but its advocacy has affected other post-Dodd Frank regulations as well. For example, nongovernmental MMFs must switch from fixed to floating net asset values (NAVs) starting this summer, and NACT in conjunction with other trade organizations has succeeded in simplifying the tax treatment. Rather than having to account for each change in value, the Internal Revenue Service issued a temporary rule that would allow “wash-sale treatment,” allow corporates to net overall gains against overall losses. Given temporary rules can be changed at any time NACT is now pushing to make that rule permanent.
“One of the objections we have to a floating NAV is that it would require system modifications to keep track of the changes, and the typical treasury management system (TMS) treats MMFs, bank deposits, and other short-term investments as having a fixed-cash equivalent that doesn’t change,” Mr. Deas said.