The Fed's regulations are still a work in progress, so end users aren't currently required to post margin in the United States. Luke Zubrod, director of risk and regulatory advisory at Chatham Financial, said what's currently known about the Fed's proposed regulations indicates that they would let banks—usually the counterparties with which treasury departments trade derivatives—set a level and require corporates to post margin to the extent that their derivatives positions exceed that level.

A margin requirement would be costly for companies that hedge with derivatives, Deas said. A survey of non-financial companies that are members of the Business Roundtable found that, on average, companies would have to put aside $269 million in cash and high-grade securities, like Treasuries, as collateral for their derivative positions, he said.

Companies in some industries, "like real estate and utilities, may not have access to assets suitable for posting to a bank, except as part of an overall financing package," Zubrod said. "So this will impact all end users to a degree, but it will impact some more than others."

He pointed to a recent survey of 43 treasurers and CFOs conducted by the Coalition for Derivatives End-Users in which 91% of respondents said a margin requirement would cause them to alter their hedging strategies. "You get a sense there of the extent to which the margin issue is weighing on people," Zubrod said.

So far, attempts at a legislative solution have not panned out. The House of Representatives has passed bills exempting end users from margin requirements, but all of those measures ran aground in the Senate, where legislators seem reluctant to contemplate any measure that would alter Dodd-Frank.

Konstantine Kastens, a public policy analyst at the Association for Financial Professionals, noted that the House passed a CFTC reauthorization measure in April that would exempt non-financial companies from margin requirements. "Whether or not that will get through the Senate is really up in the air," he said.

But Zubrod sees reasons for optimism, arguing that the Senate should now be more willing to contemplate legislation that changes Dodd-Frank. Concerns that any alteration to the law might undermine its key provisions should be eased by the fact that so many regulations now in place have implemented portions of the law.

"I think on the whole we're likely to see some kind of softening in the Senate to permit common-sense changes that are bipartisan in nature, like the margining exemption, to get through," he said.

Derivatives Regs Affect Centralized Treasury

There's also concern about how derivatives regulations will affect companies with central treasury units, which are business units within multinationals that provide financial services such as netting of risks and trading derivatives for other units of their company. Almost half (47%) of the companies surveyed by the Coalition for Derivatives End-Users said they have a central treasury unit.

Amid uncertainty about how Dodd-Frank's margin and reporting requirements apply to central treasury units and the derivatives trades they engage in with other units of their company, called inter-affiliate swaps, the CFTC tried to provide some relief in the form of a no-action letter that says regulators will not take action against the company because it didn't comply with the law, Zubrod said. "Some companies are more comfortable relying on that weak form of relief than others," he said. "I think they'd much prefer to see a rule that's coded into law."

The Coalition for Derivatives End-Users survey showed 69% of respondents either don't qualify for no-action relief or weren't sure whether they could rely on the relief, he noted.

Another challenge for treasurers involves the differences between the derivatives regulations in different parts of the world. While regulators had promised that derivatives regulations would be harmonized internationally, "there are still some areas where the rules are in conflict," Deas said.

A survey of 245 businesses worldwide conducted by the International Swaps and Derivatives Association (ISDA) found that corporate users of derivatives are shying away from trading OTC derivatives with counterparties in other regions, with 47.3% saying the new regulations were causing market fragmentation.

Among the end users that said they see fragmentation happening, 48.6% of companies located outside the U.S. said they now avoid trading with U.S. dealers, 32.8% of companies outside of Europe avoid European dealers, and 15.7% of non-Asian companies avoid trading with Asian counterparties.

"The key challenge here is the potential to be subject to multiple sets of regulations," Zubrod said. If the U.S. doesn't deem European regulations to be comparable to its rules, or if the U.S. takes a long time to conclude that European regulations are comparable, companies could spend an extended period of time being subject to both U.S. and European rules.

While large companies can handle that situation by hiring lawyers and investing in technology, it's more of a challenge for small and midsize companies with fewer resources, Zubrod said. "One of the simple things they can do is just transact within their own countries."

He noted that the financial crisis already eliminated a number of the dealers that used to trade derivatives. "The pool of large financial institutions with these capabilities has dwindled, and if you're cutting out a handful [of dealers] because of uncertainty about regulations, then you'll just transact with the folks at home, a smaller counterparty pool, with the general effect of pushing prices up," Zubrod said.

The companies surveyed by ISDA weren't happy with the market fragmentation they perceived; 56.1% said it was having a negative effect on their ability to manage their risks, while 5.1% said it was having a strong negative effect.

The changes aren't all bad news; 74.1% of the ISDA respondents said the new electronic trade execution requirements have improved market transparency. On the other hand, 81% of them said the administrative burdens relating to hedging have increased and 67.7% said the cost of hedging has increased.

Deas is also concerned about a proposed Federal Reserve rule that would limit bank holding companies' participation in the physical commodities market, arguing that restricting banks' trading in that area would subtract liquidity from the other markets used to hedge physical commodities, OTC derivatives, and futures. "It would make banks more expensive, and in the end it would cause us to hedge with a counterparty that's not regulated by the Fed," he said.

Read the May Special Report on Regulatory Update.

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