Luke Zubrod: That's a relevant question. One of the questions behind the question is: How does this latest proposal treat capital? The answer is that this rule doesn't make any change to capital requirements; it defers to the existing capital framework. But the question is still very relevant. Basel III, which is being implemented in stages over a period of years, increases capital requirements for derivatives exposures. If a corporate end user wants to do a trade with a bank, and that trade means the dealer has to set aside more capital to backstop against potential losses on the trade, the dealer needs to get a return on that capital. Dealers will get a return on capital by increasing the transaction prices corporates pay them.

The capital requirement is one of two primary forces that will likely push up derivatives transaction pricing in the near future. The other force is the initial margin that dealers now have to post. Dealers have traditionally posted variation margin to each other, so that's not a game-changer in the new Fed rule. But they traditionally have not posted initial margin to each other. Now, just as the capital rules require a dealer to set aside capital when dealing with corporate end users, they'll have to post initial margin. They're going to have to fund that initial margin, and that'll cost them something. They'll eventually pass that cost on to end users.

T&R: So the cost increase may be noticeable for corporate treasurers who use derivatives to hedge day-to-day financial risks.

LZ: Yes. It appears that swaps end users dodged the bullet on margin. But that doesn't necessarily mean they avoided the economic impact, because the economic impact is not reflected only through margin. It's also reflected through capital and funding charges, and those will materialize over the next four years, as capital and margin requirements for dealers get phased in.

T&R: How do you expect end users to respond to these higher costs?

LZ: That's interesting, because end users could make the higher charges go away by doing what they worked so hard to avoid having to do—margining the trades. If you're a derivatives end user, will you choose to post margin or clear your trades in order to reduce the transaction prices you pay, even though you're technically exempt? I've been thinking about how end users might square up that analysis. And I think it will not be a one-size-fits-all reaction across all end users. I think it'll depend on companies' cost of capital and access to liquidity.

For a company with a high cost of capital, the opportunity cost of having to sideline funds into a margin account is very substantial. If the company could put that money to work at, say, 15 percent return on investment, but instead it's forgoing that kind of return and earning fed funds on a margin account, the opportunity cost is large. Companies with a lot of physical assets, like real estate or equipment, often don't have easy access to liquidity, so they would generally pay the higher transaction costs to avoid posting margin.

But if a company has a lower cost of capital and higher access to liquidity—a large line of credit, say—it might decide it's worthwhile to tie up tens of millions, even hundreds of millions, of dollars in a margin account to save money on its hedging costs. I think companies in that situation will look at it.

T&R: Have you talked to any corporate end users about their reaction to increases in the cost of derivatives trades?

LZ: About a year ago, I asked a group of treasurers from blue-chip companies how they were thinking about the decision of whether to post margin. Of the 20 or so treasurers in the room, five said they would consider clearing or margining if the cost savings of doing so was substantial. So again, it's not one-size-fits-all, but it depends on the transaction price versus the economics of margin—where a company fits within the framework of cost of capital and access to liquidity.

We have not seen these pricing effects hit the market yet. Theoretically, in anticipation of knowing these costs are out there in the future, especially for longer-dated trades that will still be in place when higher capital requirements are phased in, you could start to see some of these costs show up in the market today. It's not clear to me why this isn't happening.

Maybe it's just a very complicated exercise to perform the calculations and integrate those calculations across asset classes and geographies. I could imagine the burden of implementing these kinds of calculations could take some time.

So, theoretically, we could see these pricing effects sooner rather than later, but practically speaking, we have not seen that happen just yet.