U.S. financial regulators eased proposed collateral requirements for swaps traded between banks, manufacturers and other firms by seeking to limit the impact on smaller companies and global liquidity.
The proposal, adopted yesterday by the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency, seeks to free so-called end users -- commercial manufacturers and other non-financial firms that use swaps to hedge business risks -- from the requirements.
The regulation determines how much collateral is necessary to reduce risk in the market for swaps traded directly between JPMorgan Chase & Co., Goldman Sachs Group Inc., BP Plc and others instead of those trades guaranteed at a clearinghouse. The re-proposal is open for public comment before completion.
“It seems like a big win and very welcome news,” said Jess Sharp, managing director for the U.S. Chamber of Commerce’s capital markets group, which has pushed for an exemption for non-financial firms. “These companies don’t pose systemic risk.”
To help end-users, regulators backed off an idea that would have required banks to force non-financial firms to post collateral if they crossed specific thresholds of creditworthiness. Banks will instead be required to collect collateral according to their own assessment of clients’ risks.
The revised proposal also is designed to lessen the impact on global liquidity by limiting how many assets are tied up in collateral. Under the draft, firms wouldn’t have to post the first $65 million of collateral prompted by their trades.
The rule also expands the types of assets that are eligible to be used as collateral to include U.S. debt, gold and certain corporate debt and equities. The rules would be phased in between December 2015 and 2019.
Overall, U.S. banks and their clients would need to have about $300 billion in initial margin -- collateral exchanged at the beginning of a transaction -- to offset risks in the trades, according to financial-industry and regulatory estimates cited by the Federal Reserve.
U.S. regulators are rewriting their rules, first proposed in 2011, to follow a plan laid out last year by a group of global authorities that sought to align standards and keep banks from exploiting differences between countries. The international plan was softened to respond to banks’ concerns that the requirements would force them to set aside the bulk of their high-quality assets and hurt market liquidity.
Ken Bentsen, president and chief executive officer of the Securities Industry and Financial Markets Association, said it is essential that U.S. and overseas regulators reach consensus on collateral standards.
The regulations, which also must be voted on in the U.S. by the Commodity Futures Trading Commission and Securities and Exchange Commission, seek to reduce risk in the market after largely unregulated credit-default swaps exacerbated the 2008 financial crisis and the downfall of American International Group Inc.
The proposal is part of global policymakers’ efforts “to reduce systemic risk in derivatives markets,” Federal Reserve Chair Janet Yellen said in a statement.
Regulators have argued that had the rules been in place in 2008, financial firms would not have amassed large derivatives positions without the necessary collateral.
“Margin is really the first line of defense against a breakdown,” Marcus Stanley, policy director for Americans for Financial Reform, a coalition including the AFL-CIO labor federation, said in a phone interview.
Airlines, utilities and manufacturers that use derivatives to hedge risks have lobbied for four years for an explicit exemption from having to post margin, arguing that such a requirement would divert funds from hiring workers or investing in their business. The 2010 Dodd-Frank Act left it to regulators to determine whether end-users would need to post margin in swaps that aren’t settled by a central clearinghouse.
The Coalition for Derivatives End-Users, including brewer MillerCoors and technology company Honeywell International Inc. have testified to Congress and met with regulators to press for an exemption.