A notice of proposed rulemaking (NPR) from joint US regulators including the Federal Reserve and the Federal Deposit Insurance Corporation has proposed new margin requirements for swap dealers and end-users, including airlines, to set aside money to reduce risk in certain trades. However similar rules proposed by the Commodity Futures Trading Commission suggested end-users will be exempt from such margin requirements.
The Dodd-Frank Act requires agencies including the CFTC, Securities and Exchange Commission and the Fed to establish margin requirements as a way of limiting risk in the global swaps market. However airlines have argued that they use derivatives genuinely to hedge risks such as fuel costs, interest rates and foreign exchange exposure, rather than for speculation. The Dodd-Frank Act is so wide-ranging and high level, US regulators were tasked with deciding whether end-users would need to post margin in swaps that aren’t settled by a central clearinghouse. The resulting lobbying action by end-users has resulted in the divergence between the two NPR documents.
The NPR issued by the Fed and four other agencies proposes that the amount of margin required would vary based on the relative risk of the counterparty and of the swap or security-based swap. “A swap entity would not be required to collect margin from a commercial end user as long as its margin exposure is below an appropriate credit exposure limit established by the swap entity. A swap entity would also not be required to collect margin from low-risk financial end users as long as its margin exposure does not exceed a specific threshold.”
What that threshold will be is unknown and regulators have attempted to minimize the impact on end-users by not setting a minimum threshold for the size or type of transaction that would require margin. It is likely, should this NPR be adopted, that some end-users will have to post margins when there are large swaps used for speculative, rather than hedging purposes. However the CFTC’s proposals do not impose margin requirements on commercial end users.
It will be interesting to see how this plays out following the 60-day comment period. However airlines have backed away from fuel hedges in recent years due to the extreme volatility in oil prices but hedging remains an effective cost management tool for the industry and you can bet it will be lobbying hard to ensure end-users remain exempt from the rules.