I’ve been getting around a bit this week. Having had long conversations with cybersecurity experts, I’ve also been having long conversations with treasurers.
Many of them.
Many of them, mainly with the world’s largest corporations.
And it’s been interesting, as they all share one over-riding common concern.
Now I thought bankers were the only ones worried about changing regulatory regimes, but corporates are just as concerned as it impacts their working capital, cashflow and liquidity as much as, if not more so, than banks.
All of this is intertwined in the increased capital requirements of Basel III, the Capital Requirements Directive (CRD) IV here in Europe and the use of OTC Derivatives generally.
Now I’ve blogged about this concern before, but these dialogues made it abundantly clear that the new regulatory regime draft of Basel III and CRD IV is unworkable.
Because it’s in cloud cuckoo land, away with the fairies, up a gum tree and will leave most banks and businesses up the proverbial creek without a paddle.
Here’s the issue.
If corporate treasurers use OTC Derivatives to hedge FX, commodities, future risk or related speculative needs to protect against future market uncertainties, the regulatory regime requires that they put up more collateral to enable this.
Posting collateral pre-trade for future trading does not make sense for a corporate, according to treasurers, so why is it needed?
Well, it’s all a bit complicated involving lots of three letter acronyms and knowledge of treasury (you can read the detail over on risk.net if you’re interested in this area), but the core of the issue is that corporates have traditionally traded on an uncollateralised basis but an unintended consequence of the European interpretation of Basel III, the CRD IV, is that they will now need to post collateral.
In fact, the co-axial elements of EMIR (the European Market Infrastructures Regulation), CRD IV and Basel III is a bit of a bugger’s muddle all in all.
As one treasurer said to me: “what it means is that banks have less liquidity, as they need to withhold capital, and corporates have less liquidity for the same reason. We simply will not post collateral and markets will therefore disappear overnight.”
Hmmm … don’t like the sound of that.
Interestingly and unsurprisingly, this was a core topic of debate at the Association of Corporate Treasurers (ACT) annual conference in Liverpool last month.
Again, risk.net covers the discussions well and I think these few paras summarise the exact situation today nicely:
Sustained lobbying won corporate hedgers an exemption from mandatory central clearing under the US Dodd-Frank Act and the European Market Infrastructure Regulation (Emir), but panellists said some companies might find they are better off choosing to clear – or finding other ways to hedge – because uncleared trades could be subject to higher capital and margin costs, which dealer counterparties have said they will pass on.
Those fears have already kicked off a second round of lobbying, with corporates arguing extra capital charges on uncleared trades – which come primarily from Basel III's new levy on credit value adjustment (CVA) – would undermine the clearing exemption. In essence, corporates could avoid the liquidity drain associated with the need to post initial and variation margin to clearing houses, but only at the cost of more expensive hedges.
A CVA exemption for corporates is under consideration by European authorities as they work on the fourth Capital Requirement Directive (CRD IV), which will implement Basel III.
Still sounds like a bugger’s muddle if you ask me, and it’s something that our CAS-WG is actively debating, for those interested or concerned.