01 May 2012

Hedgeweek: Basel 2.5 and III derivatives regulations to increase costs of capital

Corporate interest rate derivatives users participating in the most recent Global Interest Rate Derivatives Study believe that new Basel 2.5 and III derivatives regulations in Europe and the US will result in wider spreads in derivatives markets, and ultimately increase their costs of capital.

There is much less consensus that these new margin requirements and revised capital reserve requirements on banks will affect trading practices or hedging strategies.

Overall, a plurality of interest rate derivatives users think the new capital requirements regarding derivatives trading will have little to no impact on current practices, or do not feel they have enough information about the regulations to make a meaningful assessment. Of those that are concerned about direct and indirect consequences of the regulations, most derivatives users seem willing to absorb the impact of wider spreads without reducing their level of trading activity.

“It’s a much different story when it comes to margin requirements”, says Greenwich Associates consultant, Andrew Awad. “A large share of study participants predict that the need to post collateral would cause them to reduce hedging activity and/or cut back their activity in interest rate derivatives.”

Many users of interest rate swaps know that at some point they will be required to trade through swap execution facilities (SEFs) in the United States and organised trade facilities (OTFs) in Europe. At present, however, uncertainty abounds about if and how new derivatives regulations will affect the specific hedging and trading practices of companies and financials in various markets. However, the implementation of Basel 2.5 and III by some leading banks around the world has resulted in higher credit charges to bank customers, increasing transaction costs for corporate derivatives users.

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