Reform bill ambiguity means end-users might have to post margin even if they don't clear swaps.
Derivatives end-users might have to post initial and variation margin for all swap transactions that are not centrally cleared, after US lawmakers working on new US legislation omitted a clause that would exempt them from margining requirements.
The conference committee, charged with reconciling the financial regulatory reform bills passed by the US Senate and House of Representatives, reached agreement after 20 hours of wrangling in the early hours of Friday morning, June 25 - and later briefly reopened the debate. The result of their efforts - dubbed the Dodd-Frank bill - is alarming end-users.
A clause present in both the Senate and House versions of the bill explicitly exempted commercial end-users from margining requirements in non-cleared swaps, but it has been omitted from the final legislation. End-users claim their ability to hedge would be severely hampered if they were forced to post margin on uncleared transactions because regular margin payments would gobble up precious working capital - a well-worn argument lobbyists deployed to defend corporate hedgers from mandatory clearing requirements.
Our concern emanates from language deleted during the conference process
"Our concern emanates from language deleted during the conference process," says Tom Deas, president of the National Association of Corporate Treasurers in Philadelphia. "However, we want to make it clear that while deletion of this language should not alter the often-expressed intent to exempt end-user trades from margin requirements, we also would support legislation to create an unambiguous exemption from margin requirements for end-users."
The International Swaps and Derivatives Association believes if end-users are subjected to margining in non-cleared swaps, more than $770 billion of extra collateral and credit capacity will be required to meet the regulations.
According to an industry source, congressional staffers charged with drafting the bill admitted in private the omission was an oversight. However, the chance to rectify this was missed on June 29, after the conference committee reconvened in dramatic circumstances.
Amendments discussed at the reopening of the debate included one that would readmit the end-user exemption on margining. But the amendment failed after the votes tied 6-6. Christopher Dodd, chairman of the Senate Banking Committee, said although Democrats had sympathy with end-user concerns, the issue could be remedied in a subsequent bill.
The fear now is that corporate end-users have leapt from the frying pan into the fire: they might not have to use central clearing, but if they don't they might be required to post margin to their counterparties bilaterally.
The original language in the Senate bill stated margining requirements would not apply for swaps in which one of the counterparties was not a swap dealer, major swap participant, or a counterparty eligible for and using the commercial end-user clearing exemption. The text in the House bill stated margining requirements would not apply to a swap where one party is not a swap dealer or major swap participant.
But the language that remains states regulators shall jointly adopt rules for swap dealers and major swap participants, with respect to their activities as a swap dealer or major swap participant, for which there is a prudential regulator imposing both capital requirements; and both initial and variation margin requirements on all swaps that are not cleared.
"It all comes down to how the regulators interpret the legislation," says one derivatives lobbyist in Washington, DC. "It is possible transactions involving end-users are exempt from margining, but it is not looking likely, and we will probably only find out a year down the line."
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