Monday, September 28, 2009

Industrial groups warn on OTC rules

Posted in the Financial Times by Jeremy Grant:

Some of Europe’s largest industrial companies have warned they could shift their financial hedging away from Europe if proposed reforms of the vast over-the-counter (OTC) derivatives markets go ahead as proposed by the European Commission.

Executives from Lufthansa, the German airline, and Rolls-Royce, the UK engineering group, told a conference in Brussels on Friday that the Commission’s proposals for OTC derivatives reforms would hit companies that routinely use such products to manage business risks.

“The whole concept of the proposed regulation would result in a penalisation of those market participants which have true justification to be in the market,” Lufthansa said. “In contrast, financial intermediaries and speculators would not be affected. It should be the other way around.”

The comments show that opposition to a key part of US and European proposals for reform of the financial system is gathering from an unexpected quarter: industrial companies.

Many companies use OTC derivatives, such as interest rate and currency swaps, to hedge routine business risks like fuel purchases and future pension liabilities.

Lufthansa said a $1 fluctuation in the price of crude oil “has a $60m impact on our cost base”, which it tackles through hedging in the OTC markets.

The US has proposed ways to tighten regulation of OTC derivatives, which are bilaterally negotiated between two parties and not traded on exchanges. Some OTC derivatives were blamed for worsening the financial crisis.

The proposals call for swathes of “standardised”, or less complex, OTC derivatives to be shifted to clearing houses to remove risks from the system. A clearing house guarantees that a trade is completed even if parties default.

European companies say that if regulators force greater standardisation of OTC derivatives and more clearing this would cause a huge drain on cash as companies would be forced to post margin collateral to help guarantee such trades, something they currently do not have to do.

Richard Raeburn, chairman of the European Association of Corporate Treasurers, said: “Derivative contracts between non-financial companies and the financial sector should be exempt from any requirements for mandatory margining or for use of [clearing houses] with margin requirements, as non-financial companies pose no systemic risks in their use of derivatives.”

David Wright, deputy director-general of the Commission’s internal market and services unit, said: “We can’t design a system where the cost [of using OTC derivatives] is so high that it takes out derivatives that can be used to hedge. On the other hand, if we have a system with loopholes the system could be gamed. It’s a balance.”

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