US derivatives regulation will impact Asian treasurers

Pending financial reforms will require banks to put up more collateral to back trading in FX and interest rate swaps, potentially increasing the cost of these tools for treasurers.
Senator Blanche Lincoln speaking after the US Senate passed financial reform legislation in May. (Source: AFP)
Senator Blanche Lincoln speaking after the US Senate passed financial reform legislation in May. (Source: AFP)

Proposed new financial regulations in the US set out to better prepare the financial services industry for systemic risks, but their reach will be further than many lawmakers expect. Senator Blanche Lincoln's proposed changes to derivatives rules, including foreign exchange (FX) and interest rate swaps, will impact corporate treasuries in Asia.

Unfortunately, no one knows just what that impact will be.

"There's an overall concern over what additional costs, related to capital charges, that swap dealers could pass along to end-users through wider bid offers or other fees," said Jiro Okochi, chief executive and co-founder of Reval, a provider of solutions that help the end-users of derivatives better price and manage their positions.

He explained that there were some surprises in the US Senate bill in terms of FX forwards and swaps, but for the most part, he was upbeat. "At the end of reform, the theory is there will be new liquidity and new volumes in the market that will offset the cost of reform," he said. "Part of me looks at the glass half full and thinks this will help promote derivatives."

Other industry executives have similar opinions. Randy White, global managing director of liquidity solutions at J.P. Morgan, said that the proposed regulation would not change corporate funding ratios very much and that Basel III requirements were likely to have a greater impact on the cost of capital and liquidity for corporates.

All of this is good news for corporate treasurers in Asia. Most multinationals and large corporates operating in the region use currency hedges to offset their FX risk, allowing them to limit the impact of fluctuating exchange rates on their bottom lines. This is especially important today considering the volatile state of global currency markets. The pending regulation would impact currency hedges in Asia because of the US financial system's far reaching tentacles around the world; both its banks and large corporations have significant presences in the region.

"Any multinational corporate, whether they're Hong Kong- or US-based, will be forced to comply if they want to do business in the US or Europe," said Okochi. He added that the Group of Twenty nations have agreed in principle to support the reform efforts led by the US and Europe.

Bangalore-based Infosys is a good example. The majority of the company's receivables are in US dollars but its payables are largely in Indian rupees. Chief financial officer V Balakrishnan told FinanceAsia that the company maintains a hedge for up to two quarters out to mitigate its FX risk.

The current uncertainty over what changes to expect stems from the US legislative process. Both houses of its bicameral legislature -- the House and Senate -- have passed their own financial reform bills, however, in order to be signed into law by the president, they need to be identical. To achieve that, representatives of both chambers meet in a conference session to reconcile the bills; this process began two weeks ago. The Senate's derivatives regulation was drafted by Senator Lincoln's agriculture committee.

According to the latest reports, financial institutions will not be forced to spin off their derivatives businesses into separate companies as was originally feared, but will be expected to post significantly more collateral to back trades. Unfortunately, it is the latter that is of most concern to treasurers as it will most likely result in higher hedging costs.

No matter what happens with the current financial reform proposals in the US, corporate treasurers can accept at least one truth -- the cost of their FX and interest rate hedges will not go down.

But with the end-user clearly defined in legislation, the trade-off may be, according to Okochi, "as good as it can get for the corporate end-user".

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