Corporate risk

Stock market performance

Many things may have changed for corporate users of derivatives over the past 18 months, but one thing remains constant – the price has to be right. Respondents to Risk’s latest corporate survey highlight the strength of a counterparty and liquidity provision as key factors influencing their decision of which dealer to trade with. But the bottom line is the bank must offer a competitive price.

Interestingly, transparency is the third most important issue – company treasury officials want dealers to be upfront about the prices they quote and the factors that influence them. This comes on the back of some major upheavals in pricing practices in recent times. For a start, dealers are a lot more disciplined in pricing credit – a lesson learned the hard way after the collapse of Lehman Brothers. In addition, the market is moving to a new standard for pricing uncollateralised and collateralised derivatives trades. Future cashflows on non-collateralised transactions are increasingly being discounted using the bank’s own rate of funding rather than Libor. For collateralised trades, the overnight index swap rate is now being used as a discount rate (Risk March 2010, pages 19–22).

This has meant the prices on non-collateralised transactions can vary significantly, as each bank may have its own view on credit risk and will be using its own cost of funding as a discount rate – in turn, making it extremely difficult to compare quotes presented by a group of dealers.

Elsewhere, use of credit support annexes among corporates has increased, but many remain wary about the potential drain on working capital should the mark-to-market of a trade move against them and breach a certain threshold. This helps explain the strong resistance by corporates to new derivatives regulation currently being drawn up in the US and Europe. The requirement for standardised swaps contracts to be traded on an exchange and cleared through a central counterparty could hit the sector hard as a result of margin requirements, critics argue, creating a strong push for a corporate exemption. It is still unclear whether these arguments will find favour with legislators, however.

Nick Sawyer, Editor



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