In Case You Missed It: "Risk Rule Riles Main Street"

Tamara Hinton, 202.225.0184

WASHINGTON – A report in The Wall Street Journal today highlights the concerns of end-users with the recent proposed rule on margin requirements issued by the Federal Deposit Insurance Corporation (FDIC) on behalf of prudential regulators. The proposed rule is at odds with Congressional intent to exempt end-users from the margin requirement. If imposed upon end-users, it would subject them to significant cash burdens, cash that would otherwise be put to work in the economy.

The complete story from The Wall Street Journal is below:

Risk Rule Riles Main Street: U.S. Wants Car Makers, Brewers to Back Derivatives Bets With Cash; Cost at Issue
By Victoria McGrane
April 13, 2011

U.S. manufacturers, energy producers and other corporations are balking at a proposed rule they fear would drive up the cost of hedging against price swings in the commodities they depend upon, renewing a high-stakes debate over whether the regulation of derivatives should extend beyond the financial industry.

Caterpillar Inc., MillerCoors, Ford Motor Co. and other companies outside finance fought hard last year to avoid being regulated under a framework created by Congress to oversee the $583 trillion derivatives market, part of the Dodd-Frank financial overhaul. At the time, lawmakers said nonfinancial companies wouldn't have to meet the potentially costly requirement to back up their derivatives trades with cash or other assets as collateral.

But the new rule, unveiled by the Federal Reserve, Federal Deposit Insurance Corp. and other bank regulators, said banks would have to impose such requirements on their corporate clients if their exposure to these trades grew too risky. The regulators' goal is to prevent the kind of cascading panic that accompanied the collapse of American International Group, a sprawling financial concern felled by largely unregulated derivatives bets.

Regulators have repeatedly sought to assure corporations that they won't be overburdened by the derivatives rules. But the corporate world fears anything less than an iron-clad exemption could be a wedge to heavier regulation in the future.

Companies that use the complex financial instruments to hedge against risks—such as fuel prices or interest rate fluctuations—say the new rule would eat up cash that could otherwise go toward creating jobs or making investments. Some argued that the move violated Congress's intent when it passed the financial revamp last year.

Regulators don't expect any actual change in the amount of collateral that bank dealers extract from corporate counterparties as a result of the rule, said people familiar with regulators' thinking. Dealers don't require any collateral on the majority of derivatives trades with corporate end users, and the rule enables them to continue the status quo, regulators believe.

Corporations say they are nervous about the broad framework even if the current rule wouldn't affect the trades they make today, because regulators could change the parameters or indirectly pressure banks to lower the threshold.

"We fear that at the very time end users would be under the most credit constraints and find cash the tightest—namely during times of financial turmoil—that the regulators would exercise their rule-making authority to tighten the margin exemption and sweep up more end users," said Tom Deas, treasurer for Philadelphia-based chemical company FMC Corp.

Derivatives covered in the new set of rules are known as swaps: private financial contracts between two parties to exchange one asset or liability for another in the future. Airlines, for example, use swaps to hedge oil price fluctuations.

Craig Reiners, director of risk management at beer giant MillerCoors LLC, said the derivatives rules were designed to reduce threats to financial stability, whereas companies such as his "pose no systemic risks." If end users aren't shielded, the rules "would have a very harmful effect on our risk-management of the business and for that matter ultimately the cost of a six-pack of beer." MillerCoors uses over-the-counter derivatives to hedge against price volatility in areas such as aluminum, hops and energy.

The Coalition for Derivatives End-Users, an umbrella group for firms including Caterpillar Inc., Ford Motor Co., MillerCoors, Boeing Co., Duke Energy Corp. and Procter & Gamble Co., argues that regulators "misinterpret" the law and don't have the authority to impose such requirements. It also said the proposals could "divert working capital from productive uses at the costs of economic growth and jobs, or send a vibrant, secure swaps market overseas."

The Dodd-Frank financial overhaul sought to bring such trades into the open to better judge the risks they pose to the broader economy. It requires most derivatives to be traded on exchanges or similar electronic systems and routed through clearinghouses.

The law exempted end users from the clearing requirement. For trades that aren't cleared, companies and other market players must post margin, or cash collateral.

Tuesday's rule from the nation's top bank regulators said any bank selling derivatives would have to come up with a limit for its corporate clients based on their credit profile. A healthier company would have a higher limit than a riskier one. If the company exceeds that limit, the bank would be required to collect cash or other collateral from the company to put aside in case the trades go bad.

Luke Zubrod, a director with Chatham Financial, a consulting firm advising the end-user coalition, said banks and their customers today can agree to dispense with providing collateral. If the rule is approved as written, a wide range of companies could find themselves subject to the new requirements.

Regulators said the new rules won't hamper nonfinancial companies using derivatives in the natural course of business, provided they don't engage in speculative bets as AIG did. FDIC Chairman Sheila Bair said regulators need to strike a balance between protecting those users and the lax regulation of derivatives that many say fueled the financial crisis of fall 2008.

"We do not want to blow up the healthy and needed parts of the market," said Ms. Bair said.

The draft rule unveiled Tuesday is open for public comments until June 24, after which regulators may choose to revise it.

—Alan Zibel and Jamila Trindle contributed to this article.