Companies using trillions of dollars of derivatives contracts as a hedge against risks from interest rate, currency, and commodity price changes could face much higher costs under the Obama administration’s proposed overhaul of derivatives rules.
Companies usually have to put up collateral to cover potential payments in order to buy or sell derivatives. Most hedging is done between companies and banks in the over-the-counter market.
If enacted, the proposed reforms would lead to higher collateral costs, industry observers say, because they could require companies to put up cash as collateral instead of the lines of credit they have been using for this purpose.
"Highly rated companies with bank credit lines are not posting liquid collateral for derivatives," Treasury Strategies principal John Herrick told the Financial Times.
"Companies are going to resist that like crazy."
There was $396 trillion face value of interest-rate derivatives contracts outstanding at the end of June 2008, according to the Bank of International Settlements.
"There is widespread agreement that . . . derivatives, particularly credit default swaps, may have contributed greatly to the financial mess that we're cleaning up now," SEC head Mary Schapiro commented when the proposed regulations were announced.
"Unfortunately, the lack of clear regulatory authority over this vast market has hindered the ability of regulators to fully understand how the market functions or to insure that basic standards of fairness are followed," Shapiro said.
"There is full agreement now that this needs to change."
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