Europe Frets over Uncleared Swap Margin Guidelines

Non-EU corporate treasurers might soon be rethinking their relationships with European banks unless the European Banking Authority (EBA) changes its position on margin requirements for uncleared, over-the-counter (OTC) swaps.

“If regulation makes it more difficult and/or costly for businesses to do deal with European banks in this matter, it is only natural for corporate treasurers to look at what options they have,” says Magnus Carlsson, AFP’s manager of treasury and payments. “Their focus always has to be what is best for the company, and if stricter European regulation means there is a business case to switch to a non-European banks, they will do so.”

Also concerned over the potential new regime in Europe is the UK’s Association of Corporate Treasurers (ACT). “The effect will simply be that no [non-EU, nonfinancial derivative counterparty] will want to do any derivative business with a European bank,” the ACT said in its comment letter on the EBA proposal, for which comments were due July 24. “In effect, the [proposal seems] inadvertently to ban European banks from the opportunity to do business with this potential pool of corporate customers.”

Swap market participants might have to fret for several more months. The EBA must digest the 67 comment letters it received from mostly financial institutions (FIs), adjust the proposed rule accordingly, and submit it to the European Commission (EC). The EC must in turn implement any changes it sees fit, approve the rule, and then send it to the European Parliament (EP) for a final vote and approval.  

A final rule is likely to arrive in the first half of 2015 – possibly as early as the first quarter according to market sources – to provide time to implement it before the December 1, 2015, deadline set by international guidelines from the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO).

US regulators have stated on numerous occasions in recent years that the Dodd-Frank Act obligated them to require FIs to impose initial and variation margin requirements on their corporate swap clients. To the relief of corporates, however, the final rule approved on September 3 left that determination up to the banks, essentially maintaining the status quo and adhering to the international guidelines.

The EBA’s proposal, on the other hand, never required financial counterparties to request margin from corporates domiciled in Europe. However, it does require them to collect margin from all non-EU counterparties regardless of size and status, even where they are corporates, central banks or sovereigns.

Market participants say the EBA’s decision to propose margin requirements for non-EU counterparties is a measure to counter what it sees as Dodd-Frank’s overreach that subjects European banks to US regulation. The EBA could eliminate that provision or reduce its impact in the final rule, but so far there has been little indication that U.S. regulators would alter their extraterritorial requirements in return.

Michelle Price, the ACT’s associate policy and technical director, says EU regulators “officially” find other jurisdictions’ uncleared swap rules, including the US’s, to be problematic. “And they won’t budge on that until the US gives mutual recognition to the EU [rule]regime,” adds Price, who said she suspects “that if the US holds out for a very long time [the EU regulators] will go out of their way to recognise a few [other jurisdiction’s rules] to show the US is out of step.”  

Price to be Paid

While the regulators play chicken, however, derivative end users could literally pay a price. Tom Deas, treasurer of US chemicals manufacturer FMC Corporation and the International Group of Treasury Associations’ (IGTA) chairman, said a likely result of treating corporate end users differently according to their jurisdiction will be fragmentation of the global derivative market.

“With these conflicting rules, the end result could well be that counterparties will only transact a derivative with a swap counterparty in their own jurisdiction to avoid being subjugated to cross border rules,” says Deas. “The fragmentation of the market could result in worse pricing of the derivatives used by corporate end users and greater risk, because there will be fewer counterparties to trade with.”

A survey of chief financial officers (CFOs) earlier this year by the Coalition for Derivatives End-Users – a US body representing the views of companies that manage risk via derivatives – found that more than two-thirds of respondents indicated that a margin requirement on uncleared, over-the-counter (OTC) swaps would have at least a moderate impact on capital expenditures. In addition, 86% of respondents said that collateralising derivatives would adversely impact business investment, acquisitions, research and job creation.

The European Banking Federation (EBF) notes in its comment letter that imposing margin on corporate end users outside the EU is inconsistent with the guidelines from the BCBS and IOSCO. “This places EU entities which are active in non-EU jurisdictions at a major disadvantage as counterparties will choose to transact with non-EU banks instead that are not required to collect margin from corporates,” the letter states.

Luke Zubrod, director of risk and regulatory advisory at global advisory firm Chatham Financial, says the proposal is unclear on whether the US branches of European banks would also have to impose margin requirements on American corporations. He notes that the US approach has been to view foreign branches of American banks as part of the entity domiciled in the US, and flipping that paradigm to European banks’ American branches would suggest they, too, would have to impose margin on US clients.

Zubrod adds that he spoke to a lawyer who reviewed the proposal’s language. “He agreed and said it probably does apply to US branches of European banks.”

Added Complexities

The requirement would also appear to complicate matters for US or other foreign affiliates of EU-based nonfinancial companies.

“For EU based non-financial companies this would mean that their non-EU group companies would no longer deal with group-approved EU banks and their business would be directed elsewhere,” says Valerie Voisin, head of technical committees at France’s Association Française des Trésoriers d’Entreprise, in the AFTE’s comment letter.

The EBF notes other ways in which the EBA’s proposal differs from internationally developed guidelines and could impact the swap market. For example, the financial companies and large nonfinancial companies that must adhere to clearing and margin requirements because of their high swap volumes must also obtain positive agreements from nonfinancial corporate counterparties to not apply margin requirements.

The EBF comment letter claims that “this will not only result in unreasonable burdens for corporate counterparties and other counterparties which are intended to be exempted from the margin requirements but there is a real risk that the OTC derivatives market for corporates will be disrupted at the beginning of the implementation period on December 1 2015.”

Other differences from the international guidelines that mostly would impact financial swap counterparties include a ban on reusing collateral posted for initial margin, and concentration limits on eligible collateral.

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