Non-financial companies, as end-users, use OTC derivatives to hedge the impact of movements in currencies, interest rates, commodity and other prices.  This allows them to focus on their core purpose of building strong organisations, which through their growth create employment, investment and value for all stakeholders including taxpayers.

We are deeply concerned by some of the proposed reforms to the OTC derivatives market currently being considered, in that they will disadvantage many end users who rely on OTC derivatives to hedge underlying commercial exposures.  Specifically, the intent to drive OTC derivative transactions into central clearing and onto exchanges will increase liquidity risk and funding costs through the requirement to post cash collateral, and reduce flexibility to match underlying commercial exposures.

Non-financial companies do not have the same ready access to liquidity that financial institutions have.  This coupled with the requirement to post cash collateral based on unknown future financial market movements will place an excessive and inefficient burden on non-financial companies.

The economic effect of the requirement to provide cash collateral is to convert the primary risk for companies from that associated with counterparty exposure into liquidity risk.  Non-financial companies are highly experienced in managing their counterparty risk with financial institutions; managing liquidity risk in collateral requirements is substantially more difficult for them and is less efficient.

If the proposed reforms currently being considered by the European Commission are not further refined to take account of the creation of liquidity risk throughout European business the adverse effect is likely to be twofold: a reduction in the amount of funds allocated to productive investment in the economy (as liquidity must be safeguarded to support uncertain future collateral calls); and less use of prudent hedging to eliminate market risks, with a resulting increase in uncertainty and volatility in the real economy of Europe.

We are committed to working with the European Commission to propose appropriate modifications to the proposals, in a form that does not dilute the overriding requirement (which we support) to tackle the causes of systemic risk in the operations of financial institutions.  As the proposals move through the Commission and Parliament we hope that you will seek to ensure that they take proper account of the threat they pose, in their current form, to economic activity in Europe and to the Lisbon agenda to make the European Union the most dynamic and competitive knowledge-based economy in the world.

We look forward to working with you to promote financial system stability and transparency. 

Richard Raeburn
Chairman

This letter is supported by the member associations of the EACT and has been signed by the following companies... (Click here to download a PDF that includes this letter and a list of companies it is signed by)