On 11 April 2013, Thomas Deas, vice president and treasurer of chemical manufacturer FMC Corporation, chairman of the National Association of Corporate Treasurers in the US and chairman of the International Group of Treasury Associations, gave this evidence to the US House of Representatives’ Subcommittee on Capital Markets and Government Sponsored Enterprises – Committee on Financial Services.
This is an abbreviated version of his evidence regarding the regulation of derivatives under the Dodd-Frank Act.
FMC and NACT are part of the Coalition for Derivatives End Users. Our coalition represents thousands of companies across the United States that employ derivatives to manage business risks they face every day.
The coalition supports your efforts to oversee the implementation of the Dodd-Frank Act. We recognise the need to redress problems with derivatives experienced during the financial crisis in 2008. End users comprise less than 10% of the total over-the-counter (OTC) derivatives market and do not significantly contribute to systemic risk. We believe there is broad agreement with the concept that end users should not be subject to regulations designed to reduce the risk of swap dealers and others who maintain open or systemically significant derivatives positions and engage in market-making activities.
At the time of passage of the Dodd-Frank Act, we understood from a plain reading of the legislative language as well as from letters and colloquies by the principal drafters, that end users would be exempted from certain provisions intended to reduce the inherent riskiness of swap dealers’ activities. In addition, recognising the potential adverse consequences on the competitiveness of American business and ultimately on jobs here at home, regulators vowed to keep their actions in sync with those of our international trading partners and not impose any undue regulatory burdens on US end users.
However, at this point, over two-and-a-half years after passage of the Dodd-Frank Act, there are several areas where continuing regulatory uncertainty compels end users to appeal for legislative relief from actions we believe will raise costs unnecessarily and hamper our ability to manage business risks with properly structured OTC derivatives. There are three particular areas of concern:
FMC and other members of the Business Roundtable (BRT) estimated that BRT non-financial member companies would have to hold aside on average $269m of cash or immediately available bank credit to meet margin calls, assuming a 3% initial margin and no variation margin. In our world of finite limits and financial constraints, this is a direct dollar-for-dollar subtraction from funds that we would otherwise use to expand our plants, build inventory to support higher sales, undertake research and development activities, and ultimately sustain and grow jobs.
By forcing end users to post cash margin, the regulators impose a new risk. Treasurers will have new and unpredictable demands on their liquidity. Swap dealers are market makers who take open positions with derivatives and we agree central clearing and margining is appropriate for them. However, since end users are balanced, with derivatives exactly offsetting underlying business risks, forcing them into the swap dealers’ margin rules adds the considerable risk for end users of having to fund frequent cash margin payments. This will introduce an imbalance and new risks onto transactions that are matched and will settle with offsetting cash payments at maturity.
New regulations are scheduled to become effective within months that could impose on many end-user companies’ additional costs and regulatory burdens in connection with long-standing, widely used procedures they employ to net exposures within their corporate groups.
The Commodity Futures Trading Commission (CFTC) has recently announced important relief in the form of a final rule and ‘no-action’ recommendation from two of the CFTC’s divisions. Assuming several conditions are met, the final rule and the no-action relief would exempt many inter-affiliate swaps from mandatory central clearing and some reporting requirements. However, there are several areas where sought-after relief was not provided. The coalition strongly supports H.R. 677, the ‘Inter-Affiliate Swap Clarification Act’, which would address the remaining uncertainty and impermanence of the CFTC’s regulations.
Among the areas that still need legislative action are:
The Prudential Banking Regulators have proposed rules entitled ‘Advanced Approaches; Risk-Based Capital Rule; Market Risk Capital Rule’ (the Capital Proposal). The Capital Proposal implements a new credit valuation adjustment (CVA) that would increase the current capital bank counterparties would have to hold against derivatives in anticipation of a possible future deterioration in the financial markets, such as that experienced in 2008.
European policymakers seem to be enacting capital charges on derivatives positions significantly more favourable to end users than the Capital Proposal of the US Prudential Banking Regulators. Their approach is to recognise that end users’ hedging activities are in fact reducing risks; and so, should attract less capital than activities of financial entities keeping open positions or making markets in derivatives. They propose to exempt non-financial end users from the additional capital requirements for CVA risk. The absence of a US exemption will put American companies at a meaningful competitive disadvantage compared with our European competitors.
We are concerned that the regulations have imposed an uncertain framework requiring several types of end-user derivatives to be centrally cleared with mandatory posting of daily cash margin, potentially diverting billions of dollars from productive investment and employment into a new regulatory levy.
Even if the final regulations clearly exempt end users from margining requirements, we still have the risk that the banking regulators will require excessive capital be held in reserve against uncleared OTC derivatives – with the cost passed on to end users as they attempt to manage their business risks. The unintended consequence of punitive capital requirements could be for some end users to cease hedging risks or to pay hedging costs that put them at a disadvantage against foreign competition operating where end-user exemptions have been made more effective.
The consequences of getting derivatives regulation wrong will be borne by American business and, ultimately, our fellow citizens.
Thomas Deas is vice president and treasurer of FMC Corporation and chairman of the National Association of Corporate Treasurers in the US. He is also chairman of the International Group of Treasury Associations, a forum for national treasury associations to share views and information on issues that impact the treasury and finance profession. For more information, visit www.igta.org