Tuesday, May 19, 2009

Geithner plan fuels cost fears

Posted in the Financial Times by Aline van Duyn and Francesco Guerrera:

Companies using trillions of dollars of derivatives contracts to hedge interest rate, currency and commodity price risks could face higher costs under the proposed overhaul of US rules on derivatives, industry officials say.

Derivatives are widely used by the world's biggest companies to manage all kinds of financial risks. Most of these hedging activities are done between companies and banks in the over-the-countermarket.

Tim Geithner, US Treasury secretary, last week unveiled sweeping reforms, including a proposal to require clearing of all standardised derivatives through regulated central counterparties. Another proposal calls for making derivatives dealers and "other firms" - which may include non-financial companies - subject to capital charges against their positions.

Industry bodies say the reforms would lead to higher collateral costs. In order to buy or sell derivatives, companies usually have to put up collateral to cover any potential payments.

The collateral is often set against credit lines that the companies have with banks or is offset against assets. This means that companies - unlike bank users of derivatives - do not usually have to put up cash as collateral. The proposed changes might require them to hand over cash instead.

"Highly rated companies with bank credit lines are not posting liquid collateral for derivatives," said John Herrick, principal at Treasury Strategies, which advises companies on corporate treasury management. He added: "Companies are going to resist that like crazy."

David Hirschmann, a senior vice-president at the US Chambers of Commerce, said he had heard from a number of the trade group's members who had concerns over the application of the rules and the requirements to post collateral.

Of the $396,000bn face value of interest rate derivatives contracts outstanding at the end of June 2008, $38,000bn of these were with "non-financial customers", according to the Bank of International Settlements.

"A lot of large and medium-sized manufacturers rely on over-the-counter derivatives to manage their risks," said Dorothy Coleman, vice-president of tax and domestic economic policy at the National Association of Manufacturers.

The Geithner proposals still have to be approved by Congress.

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