The recent crisis made it all to easy to forget just how useful and necessary most derivatives are.
They’re not just used by financial companies or speculators, but also by major brick and mortar businesses as well.
Thus efforts to force over-the-counter (OTC) derivatives onto exchanges in Europe and the U.S. could cause a sudden cash shortage for many large non-financial companies.
This is because potential new rules could force even non-financial companies to post extra cash as margin to back their positions. Yet for companies whose core businesses provide natural hedges vs. their derivatives exposure, or other means of negotiating risk with their banks, this margin will be unecessary and highly capital-inefficient. It could even drive some companies to reduce their hedging.
As an example of the cash crunch this derivatives regulation would cause, it is reported that the European utliity company Eon may have to raise as much as 7.5 billion Euros just to meet potential new requirements.
Financial Times: “It will have a big impact … We were very surprised by the proposals, as using derivatives is just a normal part of hedging business risk,” Verena Volpert, head of finance at Eon, told the Financial Times.
Regulators in the US and Brussels are insisting that OTC derivatives be shifted on to formal exchanges and processed through clearing houses.
Non-financial companies fear this would oblige them to set aside extra cash – “margin” – to guarantee those trades. These groups nearly always do not have to post margin as they deal directly with banks.
While we hope to avoid spectacular derivatives blow-ups, unseen are the companies that are prevented from operating as well as they could be.
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