EACT backs 90-firm outcry over EBA derivatives plans

Key industry group throws weight behind big-brand corporations’ backlash against proposals to limit their use of OTC instruments

Proposals to place extra charges on derivatives transactions carried out by non-financial companies (NFCs) have been attacked in a missive from 90 big-brand corporations, with the support of leading trade body the European Association of Corporate Treasurers (EACT).

As put forward by the European Banking Authority (EBA), the measures would impose capital charges on relevant deals undertaken by NFCs, which are currently exempt from similar obligations that apply to financial firms.

That exemption is contained in major regulatory package Capital Requirements Directives, Fourth Amendment (CRD IV) – drawn up by the Basel Committee on Banking Supervision and promulgated in EU law.

In a statement announcing its move to back the 90 signatories – which count well-known organisations such as Johnson & Johnson, L’Oreal and Airbus in their ranks – the EACT argued: “Non-financial companies use OTC derivatives for reducing risks of underlying commercial and industrial operations.

“They do not enter such derivatives for speculative purposes, do not pose systemic risks by their transactions and represent a very small proportion of the overall OTC derivatives market.

“The importance of such risk mitigation has been recognised by the EU legislator, by way of granting vital exemptions for NFCs under the legislation on OTC derivatives.”

In the EACT’s view, the proposed requirements for capital charges “on the very transactions that the legislator has exempted… in CRD IV” would not only drive up the costs of risk-mitigation products, but deter NFCs from mitigating their risks and generally blight their financial positions.

EACT chair Jean-Marc Servat added that, in any case, the EBA is “not mandated to draft” the proposals, under CRD IV. “It is very worrying,” he said, “that a supervisory authority is essentially using guidelines to fundamentally amend what the legislators have democratically agreed in the framework text.”

Servat stressed: “This would be most unhelpful in the current economic context, and does not reflect the European Commission’s policy priority of promoting jobs and growth. We call upon the EBA to recognise this, and not to implement these measures that would have detrimental consequences for the real economy.”

In the letter itself – addressed to EBA chair Andrea Enria – the signatories pointed out: “Hedging is part of prudent company risk management, which contributes to financial stability by making these NFCs less risky to their financial counterparties, suppliers, customers, employees [and] economic stability.

“If the EBA even partially removes the exemption, NFCs will become more risky to their counterparties due to decreased mitigation.”

Any departure from the exemption, the letter added, is also likely to impact companies’ financial position, because it will either:

1. Force NFCs to enter into credit-support enhancement agreements with their banks that the banks’ own credit departments did not initially deem necessary. That would ultimately divert funds from productive investments. Should banks be required to obtain collateral, the corporations may end up borrowing from financial institutions to finance the margining. Then, the risk will only have been shifted within banks; from the derivatives book to the lending book. Or…
2. Increase the companies’ credit spreads in the market, because banks will be forced to mitigate counterparty risk by buying single-name, corporate-credit default swaps. Such a development would fundamentally contradict current policy objectives to facilitate companies’ access to funding.

In either case, the letter said, the banks are likely to pass on costs directly or indirectly to NFCs.

The EBA has yet to respond.

Read the full letter here.