As regulators tasked with implementing the Dodd-Frank reform of the OTC derivatives market continue the task of drafting regulations, debate continues surrounding the issue of whether end-users will be forced to post margin on their swap transactions. We addressed the central economic points in a series of posts last fall–(1) (2) (3) (4). Since then we returned to the issue as it occasionally popped back onto the radar screen. In the wake of new draft rules released in mid-April, we thought it useful to take stock once again.
There are two separate components of the Dodd-Frank reform that are the primary focus of this debate.
First, there is the mandate for a large portion of swaps to be cleared in a central counterparty clearing (CCP). Clearing entails margining. So a clearing mandate applied to end-users would require end-users to post margin. However, the law specifically exempts end-users from the clearing mandate. Debate continues over how the implementing rules will define an end-user. Everybody wants their own trades to qualify under this exemption.
Second, there is the mandate for swaps not cleared in a central counterparty clearing (CCP) to nevertheless be margined. The draft rules released earlier this month pertain to this mandate. The CFTC’s proposed rules exempt end-users from the mandate to post margin on uncleared swaps. Banking regulators—the Federal Reserve, FDIC and others—proposed rules that exempt end-users up to a certain threshold exposure, after which margin must be collected. These draft rules are now up for comment.
A variety of business interests continue vigorous lobbying campaigns targeted to expanding the end-user exemption from the margin requirement. Why?
The main argument goes something like this…
- in the old, unregulated OTC derivatives market, end-users could negotiate a swap with their dealer banks without any requirement to post margin;
- a requirement to post margin depletes an end-user’s scarce capital;
- this raises the cost of hedging and doing business; companies will be forced either to hedge less and become riskier, in turn increasing the overall risk in the system; alternatively, costs will go up , companies will be less competitive and jobs will be lost.
In the next post we’ll examine this argument.