Risk Management

Bank Reforms May Hurt European Corporates, HSBC Chief Warns

Centrally cleared derivatives are likely to cost more, he tells corporate treasurers.
Andrew SawersApril 24, 2012

European corporations could pay the price of the law of unintended consequences arising from regulatory reform, according to Douglas Flint, the chair and former CFO of banking group HSBC.

In a recent speech, he warned that corporates could be “hugely affected,” adding that their interests “should be paramount in the minds of policymakers.” Moreover, he told the annual conference of the Association of Corporate Treasurers, companies will need to spend more time in the future “understanding how your banks fund themselves.”

“Balancing the competing priorities of all the various constituencies to deliver a workable solution — without unintended consequences — has been one of the greatest challenges the industry and its regulators have faced,” said Flint.

It is also “one where strains are now beginning to show as policy design moves towards practical implementation. Creating a robust, resilient, and sustainable platform across which you, our clients, can manage your funding and your risks is essential to economic prosperity,” he told the corporate treasury officials.

Structural reforms such as ring-fencing certain types of bank operations from the rest of a banking group (a policy that has been officially recommended in the United Kingdom and is being looked at by other jurisdictions) could mean that companies need to reassess the strength of their counterparties, take on more counterparties, or enter into fresh credit support annexes. (A CSA, a derivatives contract that governs collateral management, is a key part of managing counterparty risk.)

European companies could be put at a disadvantage by some of the reforms currently being implemented or considered, said Flint. The way the European Union is currently looking to implement the Basel III bank reforms could mean over-the-counter derivatives “would attract high and potentially volatile capital charges, mainly through the so-called credit valuation adjustment [CVA] charge,” he said. (Under the Basel III agreement, corporations must take a capital charge for CVA, which is the market value of counterparty credit risk.)

“One of our principal areas of intervention is to seek to have this removed for corporate customers,” added Flint. Centrally cleared derivatives are likely to cost more. Furthermore, “it is currently uncertain whether corporations in Europe will be treated [by the rules] on the same basis as against their competitors in Asia and America.”

But even if the regulatory regime itself treats all corporations alike, Flint explained, there are pricing conventions that could put European companies at a disadvantage compared with U.S. competitors. In industries where end products are usually priced in dollars, U.S. corporations will have “less need for derivatives to manage the currency and interest-rates risks of operating in these industries, while corporates based in Europe will be among the heaviest users of such derivatives.”

The costs of such use could be significant. “Corporates could find that the cost of risk management increases by up to 300% as a result of the CVA capital charge,” said Flint.

Flint closed by calling upon corporations to engage in the debate and to provide feedback to regulators. “Candidly, representations made by you, our customers, carry significantly more weight than input from our industry, which is seen as self-serving by too many,” he said.

Andrew Sawers is editor of CFO European Briefing, a CFO online publication.