WASHINGTON (Reuters) - Energy companies, airlines and other end-users would be mostly exempt from putting up costly collateral when using uncleared swaps to hedge their business risks, under regulatory proposals issued on Tuesday.
The proposals marked a step forward in a government push, now in its ninth month, to rein in Wall Street speculation in the $600-trillion off-exchange derivatives market, a source of instability in the devastating 2007-2009 financial crisis.
Both the Commodity Futures Trading Commission, which polices derivatives markets, and Federal Deposit Insurance Corp, which regulates banks, are working to implement scores of post-crisis regulations under 2010’s Dodd-Frank law.
The two agencies voted on Tuesday to put out proposals for public comment for 60 days. That would mean the earliest next possible action on them could come in mid-June.
The FDIC and CFTC plans appeared to be heading in the same direction, but any differences could be a problem.
“Corporate end-users are going to be encouraged by the direction that this is heading,” said Paul Rowady, a senior analyst with the TABB Group, reacting to the CFTC’s plan.
One of the toughest parts of implementing the derivatives reforms, which Congress left vague in important spots, is teasing apart potentially harmful speculation in the swaps market from legitimate hedging by commercial enterprises.
Businesses with a stake in the outcome range from small firms that only occasionally use swaps, to large corporations that use them all the time, to hedge funds and giant swap dealers such as JPMorgan, Bank of America, Citigroup, Goldman Sachs and HSBC.
Dealers make substantial profits acting as middle-men in the market, which is largely conducted off-exchange, while speculating in it for their own account, as well. The dealers are fighting to protect their lucrative business models, while large corporations are trying to avoid taking on new costs.
The FDIC’s board voted on Tuesday to propose that so-called “commercial end users” generally not be required to post initial margin for normal hedging activities meant to shield themselves from swings in, for instance, commodity prices or interest rates.
They would, however, have to post margin if they used uncleared swaps for speculative trading.
And while it mostly exempts end-users, the FDIC plan would require margin for big swap dealers.
FDIC Chairman Sheila Bair said collecting margin on uncleared swaps -- those that don’t go through a clearinghouse -- could have helped avoid problems during the crisis. “It is imperative that the dealers collect margin,” she said.
The FDIC’s proposal will give swap dealers two options for determining the initial margin to be posted on uncleared swap trades. The first option is to use a standard table that regulators will create. The second would be based on how much the trade could be affected over 10 days under economic stress.
The CFTC’s proposals could be a relief to businesses as diverse as Constellation Energy, MillerCoors and Caterpillar -- all of which use swaps to manage risk.
Dodd-Frank explicitly protected end-users from posting margin for cleared trades backed by a clearinghouse. But the legislation was ambiguous for trades that are uncleared, effectively leaving it up to the CFTC to define.
Nearly one-third of all over-the-counter derivative trades were not secured by some form of collateral, or margin, last year, according to the International Swaps and Derivatives Association’s annual margin survey.
The share of deals covered by collateral rose to 70 percent from 65 percent in 2009 and only 30 percent in 2003. The sum of funds used for collateral eased to $3.2 billion in 2010.
Reporting by Christopher Doering and Dave Clarke; Additional reporting by Sarah Lynch; Writing by Kevin Drawbaugh; Editing by Tim Dobbyn