Tuesday, April 13, 2010

Industrial groups gain watchdog nod over use of OTC derivatives

Original posted in the FT by Jeremy Grant:

Industrial companies have won recognition from European regulators that they should be granted exemptions from sweeping regulation of the over-the-counter derivatives markets.

It marks a partial victory amid fears that a crackdown on off-exchange derivatives markets, blamed by some for exacerbating the financial crisis, could unfairly penalise corporate users of such instruments.

Companies on both sides of the Atlantic say being forced to use derivatives that are traded on exchanges and cleared through clearing houses, as regulators insist to make the system safer, would drain cash and prevent legitimate hedging of business risk. They include the airline Lufthansa, heavy plant maker Caterpillar and aerospace group Rolls-Royce.

Clearing requires market participants to post funds as collateral against default, something companies do not have to do since they negotiate OTC derivatives - such as foreign exchange and interest rate swaps - from banks directly.

In a "discussion paper" from the European Commission's directorate general for internal markets, regulators say that "in principle, non-financial institutions could be exempt from the clearing obligation".

It says the main mechanism for transferring risk to the real economy during the crisis was through the financial sector. "This suggests that the appropriate boundary for a clearing obligation is between the financial sector and the non-financial sector."

Richard Raeburn, chairman of the European Association of Corporate Treasurers, said: "This suggests that [the Commission] supports the need for an exemption for non-financial users. It is certainly the first time that we've seen such a clear statement."

However, the paper falls short of a "clear carve-out" that companies had sought.

It suggests three ways to approach corporate exemptions: complete exemptions (which it says has "significant downsides"); to use accounting rules to determine whether companies are speculating in OTC derivatives; or devising "thresholds" that would warn regulators if companies were making too much use of privately-negotiated OTC derivatives. The paper is being circulated ahead of Friday's meeting of EU members' "working group" on derivatives and market structures.

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