by François Masquelier, Head of Corporate Finance and Treasury, RTL Group, and Honorary Chairman, EACT
The European Union (EU) has a plan for adopting stricter capital requirements and better corporate governance for banks and investment firms (the so-called ‘CDR IV’ project). Despite the fact it only concerns financial institutions, this projected Directive could indirectly heavily impact non-financial corporations. The new rules will have to be translated into national law by the end of 2012. In this new proposal1, it appears that there will be no exemptions for exposures to corporates from Credit Valuation Adjustment (CVA) charges (regulation, part3, title VI, p.56). Should we as European corporate treasurers be worried by this part of the proposal? We certainly should. At the treasury association level, we are really concerned about the potential impact on bilateral derivatives trades, which may become very expensive due to new capital requirements imposed on banks to hold the capital to cover the CVA risk. Banks will be forced to charge more to corporates and therefore hedging may become unaffordable. As for the EMIR discussions on OTC (over-the-counter) derivatives reform, we believe that there is a very strong case for exempting trades with corporates from the CVA charge in the CRD IV.
In the draft of EMIR (European Market Infrastructure Regulation), it was recognised that, in general, transactions with corporates should be exempted from central clearing counterparty (CCP) for hedging commercial risk and under a certain threshold should receive a proportionate capital treatment. In the draft proposal, it is clear that transactions with a CCP and including collaterals will be excluded from the ‘own funds’ requirements for CVA risk (cf. article 270 CVA2 scope p. 380). It is clearly stipulated that all financial institutions must calculate the own funds requirements for CVA risk in accordance with all OTC derivative instruments. The idea is to reflect the counterparty risk run by the bank while dealing with third parties.
When calculating the own funds requirements or CVA risk for a counterparty corporate risk, a bank has to base all inputs into its approved internal model for specific risk associated with traded debt position on specific complex formulae (depending on which model adopted by the financial institution the calculations are based on). Therefore, we can clearly identify an interaction between EMIR and CRD IV on this particular issue. EU regulation on OTC derivatives contains exemptions (which we were claiming and lobbying for) from mandatory clearing for non-financial counterparties using OTC derivatives to cover pure commercial risks and where derivatives exposure does not exceed the clearing threshold (to be further determined in the regulation).
Cost of hedging transactions
However, if the capital that banks are now required to hold for non-cleared OTC derivatives transactions (i.e., without collateral) is too large due to the CVA capital charges that the CRD IV Directive would impose, banks will be forced in future to charge more to corporate treasurers. Therefore, hedging transactional risks may become unaffordable for all of us. Such a regulation could effectively block access to risk management products for end-users and limit our ability to hedge the operating business risks we are facing. Even more, it would actually increase volatility and risks on the whole financial market. The obvious risk would be to stop hedging some exposures (especially on longer terms) to reduce financial costs. Eventually it would prove to be exactly the opposite of what the EU was looking for.