Analysis: America Inc wants CFTC to feel its pain on margins

By Christopher Doering

WASHINGTON (Reuters) – Corporate America has spent a year working to persuade Washington that companies could suffer billions of dollars in collateral damage from the biggest financial overhaul since the Great Depression.

This week should give a clue to how successful that effort has been. The U.S. futures regulator is scheduled to unveil a proposal on margin requirements for swap dealers and major swap participants under the Dodd-Frank financial reform law that Congress passed in the wake of the financial crisis.

The Commodity Futures Trading Commission’s decision should shed more light on who will be required to post margin.

For many, the derivative rules are a foregone conclusion: major Wall Street banks will face much higher requirements, smaller end-users should be exempt.

But corporate giants such as MillerCoors (SAB.L: Quote, Profile, Research)(TAP.N: Quote, Profile, Research) and Royal Dutch Shell (RDSa.L: Quote, Profile, Research) fear they may be caught in the gray area separating the systemically important players in the $600 trillion swaps market and those who are simply managing their own risk.

Many of these big companies have worked to convince lawmakers that average Americans, their customers, could be affected by one of the biggest financial reforms — payment of margins to guarantee they will make good on derivative deals.

Baltimore-based Constellation Energy Group (CEG.N: Quote, Profile, Research), which serves 30,000 commercial customers including Wal-Mart (WMT.N: Quote, Profile, Research) and Home Depot (HD.N: Quote, Profile, Research), says it could struggle to keep volatile power prices in check if its trading operations are limited.

“The real implication of forcing energy providers and other businesses to hold hundreds of millions, if not billions of dollars, in margin accounts is that all you’re going to do is needlessly raise costs for consumers,” James Connaughton, an executive vice president responsible for government relations, told Reuters last month.

“You’re going to create new windfalls for Wall Street, and at the same time increase risks on Main Street, when the law is supposed to be reducing them.”

Houston-based Swift Energy (SFY.N: Quote, Profile, Research) says it could be forced to abandon projects to drill for more domestic natural gas — a priority in President Barack Obama’s new energy plan — unless it can lock in future prices without tying up excess capital.

Jeff Smisek, the chief executive of United Continental (UAL.N: Quote, Profile, Research), said last month his airline hedges about 40 percent of its fuel needs for the year, and recently was consuming about $25,000 of jet fuel every minute.


Companies want to ensure they are not ensnared in Dodd-Frank, which they hope will exempt commercial end-users, such as energy firms, from posting costly margin when they clear trades done to minimize risk at their business. Such an exemption would free up millions of dollars.

Large companies have argued for a generous exemption because they use derivatives mainly to hedge risk from swings in raw-material prices or fluctuations in interest rates, insisting they do not risk destabilizing the financial system.

But confusion over what Congress intended has effectively left it up to the Commodity Futures Trading Commission — a once-obscure agency thrust into prominence by financial reform legislation enacted last year — to determine what happens to end-users and whether they must post margin.

The cost could be staggering. A study by a coalition of business groups, including the U.S. Chamber of Commerce, estimated a 3 percent margin requirement on swaps used by Standard & Poor’s 500 companies could cut capital spending by $5.1 billion to $6.7 billion and cost up to 130,000 jobs.

For U.S. utilities alone, a margin requirement on all over-the-counter swaps would affect cash flow by $250 million to $400 million a year for each company, the Edison Electric Institute, a Washington trade group, has estimated. It said that would be “dead money” funded by its members.

After months of seeking to assure real end-users that he does not intend to force them to pay margin, CFTC Chairman Gary Gensler will show his hand this Tuesday by releasing the first draft of the specific rules that will determine which firms will be forced to pay margin costs — and which will not.

If commissioners agree, those rules will be released for public comment; the CFTC must vote on them again before they are finalized. It has already proposed dozens of new regulations since October to implement its share of the reforms, which gives it oversight of the swaps market.

The Federal Deposit Insurance Corp’s board also will meet on April 12 to discuss swap margin requirements for banks. That same day, Gensler will join Securities and Exchange Commission Chairman Mary Shapiro and other officials in front of the Senate Banking Committee at a hearing on derivatives.

Senators are expected to press regulators about whether the rules will divert companies’ working capital from economic growth.

Republicans and Democrats have accused the CFTC of moving too fast. Some have called for a delay to collect more data and determine what impact the measures will have on the market.


Nine months after lawmakers passed the financial regulatory reform, the uncertainty has shown no sign of abating.

Some U.S. businesses are hoarding cash on the assumption they may need to put up margin calls soon.

“If you look at the amount of cash that’s just sitting on people’s balance sheets, a lot of that is being withheld because of the uncertainty of Dodd-Frank,” said a regulatory executive at a major U.S. energy company.

Efforts to hedge have grown in importance amid surging commodity prices for everything from corn and cotton to oil.

Connaughton said Constellation could be forced to reduce spending on projects that help consumers improve energy efficiency, or cut back on capital used to build renewable energy plants such as a wind farm.

All this, he said, comes as other regulatory bodies are imposing additional requirements, such as a demand by the U.S. Environmental Protection Agency that energy companies cut pollution from coal-powered plants. Dodd-Frank exacerbates an already uncertain environment, Connaughton said.

“It would tend to lead them to decline to do some deals or structure some deals, to not lock themselves in over the long term where the regulatory environment could turn unfavorable and those deals could be a lot more expensive to fund in the future than they anticipated,” said Craig Pirrong, a finance professor and regulatory expert at the University of Houston.


As much as the capital requirements, many companies fear the additional administrative burden will complicate already complex and time-consuming operations.

Constellation has about 250 people involved in the company’s hedging operations, conducting as many as a thousand transactions a day. Big deals can sometimes pass through a dozen departments covering weather to legal to strategy.

Transactions vary in complexity, and are rarely alike. If the customer does not know how much power it will need, the manager might buy a variety of contracts: forward contracts that operate around the clock, others that provide energy during peak periods and a call option to manage uncertainty.

Bruce Vincent, chairman of the Independent Petroleum Association of America and president of Swift Energy, said capital margin rules could reduce investments.

For example, Vincent said if he wanted to search a field for natural gas, a price of $5 per million British thermal units could make the project financially doable whereas $4 might cause losses. To lock in the $5 price, he might put in place swaps for the next three or five years, drill the well, and know he will protect his capital investment.

“The bottom line is I wouldn’t make that decision to drill all those wells if I was subjected to all that price risk,” he said. “Ultimately, you’ll have less domestic production, which will ultimately lead to higher imports and … higher prices.”

Ultimately, that’s the message companies hope will get through.

“This all comes back to higher costs for consumers, utterly unnecessary costs for consumers,” Constellation’s Connaughton said.

(Editing by Dale Hudson)

Analysis: America Inc wants CFTC to feel its pain on margins