Rising cost of risk tools daunts Europe companies

LIVERPOOL, England, April 19 Thu Apr 19, 2012 10:09am EDT

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LIVERPOOL, England, April 19 (Reuters) - European companies are increasingly alarmed that new rules on derivatives could leave them paying threefold for vital tools for managing risk or more exposed if they shun them, ultimately hampering growth.

Derivatives are used, for instance, to hedge against currency or interest rate fluctuations.

But banks are being told to hold more capital against these tailor-made instruments they arrange for companies, meaning they could end up charging more.

Regulators have been clamping down on derivatives in Europe and the United States after some of the complex versions of these deals, and the speculative way in which they were used, were blamed for exacerbating the financial crisis of 2008-9.

Companies could alternatively bypass banks and use central clearing counterparties for their derivatives trades, a system lenders themselves are forced to use by regulators.

But that could end up being even more expensive and tricky to manage for companies which would have to post collateral as margin to cover risks.

While banks can deploy a range of securities as collateral, such as government bonds, companies might have to raid cash piles.

"The need to have more liquidity available for margin calls would be my concern," said Tim Hayter, group treasurer at disposable products supplier Bunzl, speaking at the annual conference of the Association of Corporate Treasurers.

"We have headroom available to run the business for acquisitions, and I don't want to go to my financial director and say I need 50-60 million (pounds) of that to go off to pay for margin calls."

Bunzl said this week it was in deal-mode after a good start to the year, while many other companies are in cautious mode, hoarding cash and shunning acquisitions.

EXPANSION BARRIER

Expensive derivatives could make firms that want to grow think twice about investing outside their home turf as cash flows in different currencies require hedging.

In certain businesses, such as oil, dollars are the prevailing currency for trading, meaning European energy firms which have to hedge the currency risk could end up at a disadvantage to U.S. rivals.

Regulatory changes could affect even the biggest and best-funded companies.

"Companies are being told to have diverse funding, but if a UK firm wants to get working capital in dollars, they'll also want to use derivatives to convert that. And in turn they're effectively being told that derivatives are bad and they shouldn't use them," said one derivatives sales banker, who was not authorised to speak to journalists.

MIXED LOBBYING SUCCESS

Companies and banks alike have lobbied for exemptions from various aspects of the new rules, with mixed success.

Under the European Market Infrastructure Regulation, regulating derivatives, companies will not be forced to clear their trades through central counterparties as long as they are using them to hedge risk and not to speculate.

But new Basel regulations being applied in Europe mean banks face capital charges depending on fluctuating values of their derivatives trades with companies.

"The cost of risk management could increase up to three times as a result of the imposition of a CVA (credit value adjustment) capital charge, which again reinforces our desire and lobbying to try and remove this charge for corporates," Douglas Flint, Chairman of HSBC, told the corporate treasurers.

On balance, most companies said they would rather still deal with their banks than go through central clearing. One benefit of this approach is that lenders desperate for business may not end up passing on all of the added costs.

"Competitive pressures will make (the effect of derivative rules) more moderate," said Rick Martin, group director for treasury and investor relations at Virgin Media. "What is the quid pro quo for that? It is prospectively diminished financial institution profitability."

But banks are under increasing pressure from investors over returns, and companies may not be able to count on all lenders giving them cut-price rates.

Banks could also cancel out some of the capital burden of derivatives trades with companies by themselves hedging those trades with other derivatives such as credit default swaps (CDS), a form of protection against default. (Editing by David Cowell)

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