An Analysis of the Coalition for Derivatives End- Users Survey on Over-the-Counter Derivatives

Transcription

1 An Analysis f the Calitin fr Derivatives End- Users Survey n Over-the-Cunter Derivatives Prepared Fr: Calitin fr Derivatives End-Users Prepared By: Keybridge Research February 11, 2011 K E Y B R I D G E R E S E A R C H LLC 3050 K S T R E E T N W, S U I T E W A S H I N G T O N DC K E Y B R I D G E R E S E A R C H. COM

2 I. Intrductin With the enactment f the Ddd-Frank Wall Street Refrm and Cnsumer Prtectin Act ( Ddd-Frank ), the ver-the-cunter ( OTC ) derivatives market in the U.S. will cme under greater regulatry scrutiny. Specifically, Title VII intends t impse a series f new regulatins n transactins executed in the OTC derivatives market. Amng ther significant changes, the prpsed regulatins plan wuld subject Swap Dealers and Majr Swap Participants t capital and margin requirements n cleared and nn-cleared transactins. Althugh exemptins may apply fr certain nn-financial firms, there remains sme ambiguity ver the extent f these ptential exemptins. This mem reprts the results frm a recent survey cnducted by the Business Rundtable, the U.S. Chamber f Cmmerce s Center fr Capital Market Cmpetiveness, Chatham Financial, and the Natinal Assciatin f Crprate Treasurers. This survey prvides fresh data n the ptential impacts f Ddd-Frank s OTC derivatives prpsed regulatins, and als acts as a fllw-up t a previus survey cnducted by the Business Rundtable n similar tpics. II. Survey Descriptin In respnse t the current debate n OTC derivatives regulatin, a recent survey cnducted by the Business Rundtable ( BRT ), the U.S. Chamber f Cmmerce s Center fr Capital Market Cmpetiveness ( U.S. Chamber ), Chatham Financial, and the Natinal Assciatin f Crprate Treasurers examined the usage f OTC derivatives t gauge the ptential effects f Ddd-Frank. The derivatives survey was drawn frm a sample f BRT and U.S. Chamber cmpanies, and was in the field frm Nvember 3, 2010 until January 7, Of the 74 cmpanies that participated in this survey, 72 firms reprted the use f OTC derivatives, and 66 firms prvided data n the ntinal amunts f their respective OTC derivatives expsure. Keybridge Research was asked t use the survey respnses t cnduct an analysis f the ptential ecnmic impacts f OTC derivatives regulatins. 1 III. Key Findings Nearly 61% f survey participants reprt that prpsed regulatins wuld have a mderate (28%) t significant (33%) impact n the level f wrking capital required t perate their business; 18% say the new rule wuld have minimal impact; and 18% f firms remain uncertain abut the impacts f Ddd-Frank. Of the 74 survey respndents, 66 prvided data n the ntinal amunts f their derivative expsure. Fr these cmpanies, the ttal grss ntinal amunt was $422.2 billin, r $6.4 billin per cmpany (median: $730.0 millin) Fr the 66 firms that prvided detailed derivatives data, a 3% margin requirement, assuming n exemptins, wuld result in aggregate cllateral f $12.7 billin. On average this wuld be equal t $191.9 millin per firm, r rughly 1% f revenue. Extending the analysis t the S&P 500 cmpanies, this analytical nte estimates that a 3% margin requirement n OTC derivatives culd be expected t reduce capital spending by 1 Keybridge Research did nt participate in the design, sampling, implementatin, r gathering f respnses fr this survey. 2

3 $5.1 t $6.7 billin per year, leading t a lss f 100,000 t 130,000 jbs, including bth direct and indirect effects. IV. Detailed Findings 4.1 Use f Derivatives 97% (72/74) f survey participants use derivatives. The respnding cmpanies represent $1.03 trillin in revenues (equivalent t rughly 8 percent f U.S. natinal GDP) and mre than 2 millin emplyees (as f 12/31/2010). 66 cmpanies reprted the amunt f OTC derivatives expsure as f 9/30/2010 r at the end f the mst recent quarter. The cmbined ttal net market value f utstanding OTC derivatives was $10.3 billin, and the ttal ntinal value was $422.2 billin. The median and mean OTC derivatives expsure were $730.0 millin and $6.4 billin per cmpany (ntinal value), respectively. 47 f the survey participants are nn-financial firms their cmbined ttal net market value f utstanding OTC derivatives was $6.3 billin as f 9/30/2010. The ttal ntinal value f OTC derivatives was $241.1 billin, and the median ntinal expsure was $1.2 billin. The median rati f OTC derivatives (ntinal value) t ttal assets was 14.9% fr all cmpanies, and 17.1% fr nn-financial firms. Firms reprt using almst tw thirds (62%) f their derivatives t manage interest rate risk; 27% t hedge freign currencies; and 16% t hedge cmmdity prices. In line with this prtfli breakdwn, firms reprt that interest rate expsure (72%) is the greatest risk hedged with OTC derivatives, fllwed by freign currency expsure (22%) and cmmdity price risk (6%). 41% f firms reprted that derivatives usage perfectly matches the underlying risks assciated with hedging price mvements f freign currencies, interest rates, and cmmdities. Almst half (48%) say that derivatives "mstly" (51-99% f the time) match these risks, and 11% f firms perfectly hedge their underlying risk less than half the time. Tp Three Risks Hedged With OTC Derivatives 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Cmmdities, 6% Frex, 22% Interest Rates, 72% Cmmdities, 13% Frex, 48% Interest Rates, 39% Cmmdities, 57% Frex, 14% Interest Rates, 29% Greatest Risk Secnd Greatest Risk Third Greatest Risk 3

4 4.2 Derivatives Trading Operatins A majrity f firms (71%) transact with 10 cunterparties r less. 43% f firms transact with 5 r fewer cunterparties, 28% f firms transact with 6-10 cunterparties, 15% transact with cunterparties, 6% transact with cunterparties, 8% transact with mre than 40 cunterparties. Almst ne quarter f firms (24%) reprt ging thrugh an affiliate t execute swaps, while 76% f firms d nt execute swaps thrugh an affiliate. 28% f firms have an entity within their respective cmpanies that engages in swaps and is predminantly financial in nature; 72% f firms d nt have such an entity. 4.3 Cllateral & Margin Requirements A majrity f firms (61%) have credit supprt annexes in place that wuld require cllateral psting in certain circumstances, while 39% d nt have annexes requiring cllateral psting. Fr financial firms that have made cllateral arrangements, 88% f firms are bund by bilateral requirements and 13% by unilateral requirements. Fr nnfinancial firms, 59% and 41% have agreed t bilateral and unilateral requirements, respectively. As f the mst recent quarter, firms psted a ttal f $1.6 billin in cllateral. Fr firms that reprted an amunt greater than zer, the average psting was $67.2 millin. T reserve adequate amunts f cash and cmmitted credit t meet margin requirements, firms must be able t estimate the pssible mark-t-market mvements ver the life f derivative instruments. Currently, nly 30% f firms are ding this r in the prcess f ding it. 24% f firms have systems in place that culd d real-time mark-t-market calculatins f their derivatives prtfli (independent f calculatins dne by cunterparties). 68% f firms d nt have systems in place t d these calculatins, and 9% f respndents are unsure. 4.4 Ptential Impact f New Regulatins In general, rughly 61% f survey participants reprt that the prpsed regulatins wuld have a mderate (28%) t significant (33%) impact n the level f wrking capital required t perate their businesses; 18% say the new rule wuld have minimal impact; and 18% f firms remain uncertain abut the legislatins ptential impacts. Amng the three mst cncerning derivatives-related regulatry requirements, 56% f firms are cncerned with margin requirements, fllwed by central clearing (24%) and capital (24%) requirements. Mst respndents (91%) said that transactins csts assciated with trading wuld likely increase due t higher margin and capital csts placed n cunterparties. In respnse t higher csts, 68% f firms wuld likely reduce hedging, while less than a third f firms wuld likely cntinue their current level f hedging. Likewise, three ut f fur firms (77%) said they wuld cnsider alternative means f managing risk, 41% wuld increase pricing t end custmers, and 23% wuld shift risk t custmers r suppliers. As fr specific impacts f new regulatins n business activities, 31% f firms reprt that new 4

5 capital requirements wuld have a cmbined impact n business investment and expansin plans, acquisitins, and jb creatin activities. Anther 33% said that the primary impact f new derivatives regulatins wuld be their effect n business investment and expansin plans. Only 27% f firms reprt n anticipated impacts f new derivatives regulatins f these firms, 53% had little r n reprted derivative expsure. Impact f New Capital Requirements n Business Activities Nte: Percentages d nt ttal t 100%, because survey participants were permitted t prvide mre than ne respnse t this questin. Fr example, a single cmpany culd reprt that Acquisitins and Jb Creatin wuld bth be impacted by new derivatives regulatins. One pssible respnse t Ddd-Frank wuld be a shift in hedging activities t freign jurisdictins. 46% f respndents indicated that they wuld evaluate the ability t transact in freign jurisdictins as a result f OTC restrictins and regulatins in the U.S. 40% f firms are cncerned that reprting requirements in Title VII will facilitate frnt running, thus raising the csts assciated with hedging activities, while 47% f firms are uncertain abut these impacts. 13% d nt think Title VII will increase the risk f frnt running. Overall, many firms are uncertain abut whether and hw they will be subjected t different requirements. Fr instance, nearly half f firms are unsure whether central clearing and trading requirements wuld apply t them (44%) r whether they will be required t pst cllateral fr hedges that have nt been centrally cleared (49%). This uncertainty explains why 50% f respndents are nt sure whether they will disclse the impact f Ddd-Frank n their next financial statement. 5

6 V. Financial & Ecnmic Implicatins Regulatins requiring 3% cash cllateral n OTC derivatives culd result in a significant diversin f cash flw frm nrmal perating and investment activities. 2 The analysis perfrmed by Keybridge Research, belw, prvides a rugh estimate f the ptential impact f a 3% margin requirement n all OTC derivatives t the survey respndents and t cnstituents f the S&P 500 alne. The analysis des nt include an estimate f the ptential impact f requirements t pst variatin margin. The analysis assumes n exclusins frm the margin requirement, and des nt accunt fr any ther ecnmic r plicy actins (e.g., tax legislatin that wuld allw fr 100% write-ff f capital spending in 2011). The analysis fllws the fllwing methdlgy: (1) Calculate the median rati f [ntinal value f] OTC derivatives-t-assets fr survey respndents; (2) Use this rati t estimate the ntinal values fr S&P 500 cmpanies; (3) Assume a 3% margin requirement paid in cash; (4) Use respected academic literature t estimate the likely reductin in fixed capital spending as the result f the reduced cash flw. Fllwing the abve methdlgy, the analysis indicates that a 3% margin requirement n OTC derivatives culd result in a significant ne-time reductin in cash balances and an estimated 1.5% decrease in capital investment amng S&P 500 cmpanies. As f 9/30/2010, the median rati f OTC derivatives (ntinal value) t ttal assets fr survey participants was 14.9%. This rati, based n 66 respnses, was then applied t all S&P 500 cmpanies. The ttal estimated ntinal value f OTC derivatives fr S&P 500 cmpanies wuld be $3,334.9 billin. A 3% margin requirement wuld result in a ne-time reductin in cash flw f $ billin fr S&P 500 cmpanies. This is equal t abut 7.4% 3 f the S&P 500 cnstituents cmbined cash flw fr Academic literature finds that reductins in crprate cash flw lead t reductins in business fixed investment (capital spending). A leading academic study finds that a 1% 2 The 3% initial margin figure is illustrative nly and is nt a predictin f what regulatrs may impse, directly r indirectly. The Calitin fr Derivatives End-Users believes that the Ddd-Frank Act des nt prvide regulatrs with the authrity t impse margin n end-users. While CFTC Chairman Gensler has indicated that his intent is nt t impse margin directly n nn-financial end-users, the Calitin remains cncerned that the CFTC and/r prudential regulatrs (a) might attempt t impse margin indirectly n end-users, thrugh cunterparties r therwise, (b) have nt expressed agreement with the Calitin psitin n authrity t impse margin (and, hence, culd attempt t impse margin n nn-financial end-users in the future), and (c) might attempt t impse margin directly n financial end-users. 3 As f January 24, 2011, Blmberg reprts S&P 500 cash flw per share as fr December 31, With an apprximate multiplier f 9.087, this results in an aggregate cash flw f $1,348 billin. 6

7 reductin in cash flw/lagged net capital (CF/LNC) leads t a 0.06 t 0.07 reductin in the rati f capital expenditures t lagged net capital (CX/LNC). 4 Fr the S&P 500, the $ billin decline in cash flw wuld reduce in the rati f cash flw t lagged net capital (CF/LNC) by abut 0.44%. The resulting decline in the rati f capital spending t lagged net capital (CX/LNC) wuld average apprximately t This means that in aggregate S&P 500 cmpanies wuld likely respnd t the impsitin f margin requirements n OTC derivatives by reducing capital spending frm 1.96% f net capital t abut 1.93% f net capital r apprximately $5.1 billin t $6.7 billin (abut 1.5% f ttal capital spending fr the S&P 500). Based n an analysis f the jbs multipliers prduced by the U.S. Department f Cmmerce s Bureau f Ecnmic Analysis, every $1 billin in capital spending creates apprximately 19,643 jbs including bth direct and indirect effects. 5 Therefre, a 3% OTC derivative margin requirement impsed n derivatives trading by S&P 500 firms might be expected t eliminate apprximately 100,000 t 130,000 jbs ecnmy wide. 4 Hvakimian, Armen G. and Hvakimian, Gayané, Cash Flw Sensitivity f Investment (Nvember 23, 2005). Available at SSRN: In the case f cmpanies psting a 3% margin requirement fr OTC derivatives, cash flw will take a ne-time hit. Future net capital will decline, but lagged net capital which is assumed t be prir t the margin requirement payment will be unchanged. Therefre, the next perid s capital investment shuld decline in respnse t the drp in cash flw-t-lagged net capital. 5 The jbs multiplier was created as a cmpsite f the fllwing 13 sectrs: Cnstructin, Oil and gas field machinery and equipment, Paper industry machinery manufacturing, All ther industrial machinery manufacturing, Office machinery manufacturing, Other cmmercial and service industry machinery manufacturing, Special tl, die, jig, and fixture manufacturing, Turbine and turbine generatr set units manufacturing, Electrnic cmputer manufacturing, Other cmmunicatins equipment manufacturing, Autmbile and light truck manufacturing, Sftware publishers, and Custm cmputer prgramming services. These industries are bradly representative f the main categries in the Bureau f Ecnmic Analysis s Natinal Incme and Prduct Accunts investment spending. 7