You didn’t think you were going to walk away unscathed, did you?

The historic Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is now law. The 2,300-page statute takes aim at the financial-services industry, imposing a raft of new regulations and capital requirements on banks and other financial institutions, all with the goal of heading off any possible repeat of the financial crisis that brought the nation to its knees in 2008. But reform on that scale has many ripple effects, and some will inevitably wash over bank customers. While the full impact will not be known until regulators hash out final rules for enforcing the act, there are a number of areas where it is clear that Dodd-Frank will affect nonfinancial companies and their relationships with their banks.

Capital, Cost, and Credit

The overarching concern among finance executives who have tracked the legislation is that compliance will impose on banks heavy additional costs that they will pass along to their customers — making financial services, and bank credit, harder to get and more expensive. Dodd-Frank not only promises voluminous new regulations — it requires federal agencies to draft 533 new rules, conduct 60 new studies, and produce 94 reports over the next four years — but it also imposes new capital requirements on banks and other financial-services firms.

As one example, the act requires that the Federal Reserve establish risk-based capital requirements and leverage limits for “systemically important” financial institutions that are more stringent than those for nonsystemic firms. Systemically important institutions — those whose failure could conceivably cripple financial markets — will include bank holding companies with total consolidated assets of $50 billion or more, nonbank companies that derive at least 85% of their annual consolidated revenues (or at least 85% of their consolidated assets) from financial activities in the United States, and large insurance companies identified as systemically important by the Federal Insurance Office.

(Coincidentally, these new capital requirements are being developed just as the Basel Committee on Banking Supervision has debuted new rules that will boost capital requirements for global banking institutions. Those rules will take effect in stages from 2013 through 2019.)

“Some large financial institutions used to have 40:1 leverage ratios,” observes Don Ogilvie, independent chairman of the Deloitte Center for Financial Services, which is part of Big Four consulting firm Deloitte LLP. “Under the new regulations, combined with the capital requirements outlined in Basel II, they’re going to have, at the maximum, leverage ratios of 10:1 to 15:1. We’re going through a great period of deleveraging, so there just won’t be as much money available from financial institutions going forward.”

Attorney Ernie Patrikis, a partner in the bank and insurance regulatory practice at New York–based law firm White & Case LLP, questions whether this will encourage the growth of the so-called phantom banking system, including hedge funds and other institutions that have not been subject to oversight by the Federal Reserve.

“If somebody doesn’t have to pay all the costs of supervision, doesn’t have to maintain all the capital, doesn’t have to have reserves with the Fed and all these other things, you have to ask yourself whether they might have an advantage and can offer lower borrowing rates,” Patrikis says.

Spotlight on Derivatives

Beyond the general availability and cost of credit, the Dodd-Frank Act promises to bring dramatic change to the over-the-counter derivatives market, which for the first time will be subject to government regulation. Among the most sweeping reforms is a requirement that most plain-vanilla derivatives — “standardized,” in the language of the legislation — be traded on an exchange or similar “swap execution facility.”

Where that is not possible, over-the-counter derivatives will have to be cleared through a regulated clearing organization, if such an organization will accept them. Finally, where that doesn’t happen, trades will have to be reported to a central data repository and higher capital and margin requirements may be imposed on dealers and what the legislation refers to as “major swap participants.”

The overall goal is to provide greater transparency to the derivatives market and reduce systemic risk. Proponents argue that the changes also will improve liquidity in derivatives markets and reduce hedging costs for corporate end-users.

Many finance executives aren’t so optimistic. They note that contracts traded on an exchange or cleared in some fashion typically require buyers and sellers to post margin against their positions daily. “If treasurers have to tie up millions of dollars a day in margin, that’s money they’re not using to hire workers, or to invest in R&D or new technology,” says Cady North, senior manager of government affairs for Financial Executives International (FEI), an association for senior finance executives. Some observers suggest the new law may drive derivatives trading overseas.

It is still possible that regulators will exempt most corporate end-users from posting margin; preconference versions of the act actually provided for this. The version signed into law, however, includes only a limited end-user exemption, and North warns that even if end-users are exempted it won’t necessarily nullify the margin issue. There is a concern that major swap dealers will pass costs on to customers if they are not granted some kind of exemption.

“Costs may go so high that it becomes prohibitive for companies to enter into these contracts,” North says. The result could be that “they won’t manage risks such as currency fluctuations, or they may have trouble growing or moving money around on a regional basis or purchasing equipment in one country and bringing it into another.”

Steven Kasok, treasurer of Millipore Corp., a $1.7 billion U.S. unit of German pharmaceutical and chemical company Merck KGaA, doesn’t expect corporations to stop hedging their risks, but he is worried that it will cost them more. Banks saddled with new regulatory costs, from higher reserving requirements to clearing fees, will likely pass those costs on to their customers, he says.

At his own company, Kasok says, an increase of just 2 basis points in the cost of his foreign-exchange hedging program would cost his company $500,000 (or the equivalent of nearly one cent per share when Millipore was publicly traded). “This is real money,” he says, “and could easily equate to three to five jobs.”

While Kasok says it’s hard to say whether those jobs would actually be cut, “at an absolute minimum it takes that amount of earnings away from our shareholders and moves it to the financial institution and the newly created swaps intermediary.”

Unintended Consequences

Many financial executives also worry how the law of unintended consequences will intersect with the new laws of Wall Street. There has already been one eyebrow-raising mash-up. Shortly after President Obama signed the Dodd-Frank Act into law on July 21, the three major credit-rating agencies, citing concerns about the more stringent liability standards they face under Dodd-Frank, briefly refused to allow issuers of asset-backed securities to include their ratings in their offering documents as has long been required by law. Their sudden pullback shut down the ABS market until the Securities and Exchange Commission granted ABS issuers a six-month period to issue new securities without including credit ratings in their offering documents, while giving the agencies that time to adjust to the new Dodd-Frank liability standards.

Other potential hazards loom. For example, to reduce systemic risk to the financial markets, Dodd-Frank’s “Volcker Rule” restricts banks to committing no more than 3% of their Tier-1 capital to proprietary trading. To the extent that that reduces bank participation in the derivatives markets, finance executives say, it could reduce liquidity and so drive up costs.

That is actually not all bad in the view of Millipore’s Kasok, who says he would happily give up some liquidity if it reduced market volatility attributable to speculative trading. At the same time, he concedes that it is hard to know just how much of the market’s liquidity speculators have been responsible for. That makes it hard to forecast the impact their reduced participation would have in the marketplace.

Ian Cuillerier, a partner in the structured finance and derivatives practice at White & Case, also questions whether increased transparency in the derivatives market might make it more expensive for banks — and hence their clients — to execute very large derivatives transactions. The problem could arise, he explains, if a bank clears a large trade with a corporate end-user and then, as potentially required under Dodd-Frank, immediately reports the details of that transaction to the marketplace. Typically, the bank will hedge its own risk on that trade by entering into a second transaction with another counterparty. Having been apprised of the first deal, Cuillerier says, other market makers might drive up the bank’s costs on the second transaction.

Whether this will happen depends to a large degree on how regulators write the rules enforcing Dodd-Frank. There has been discussion, for example, about exempting large trades from real-time reporting requirements. The act gives regulators a year to come up with the rules, and it is widely expected that they will release a large number for comment over the next three months.

Questions about Reg Q

In the aftermath of the stock-market crash of 1929, Congress passed a law — Regulation Q — prohibiting banks from paying interest on business checking accounts. The Dodd-Frank Act cancels it, with implications good and bad for bank customers. On the plus side, it provides an opportunity for corporate customers to earn interest on their deposit accounts. But like so much else with
Dodd-Frank, that comes with consequences.

“Repealing Regulation Q raises the cost of funds for banks,” says Laurie McCulley, managing director at Chicago-based consulting firm Treasury Strategies Inc. “They’ll have to find a way to make up for that, which may translate into higher service fees for corporations.”

Corporate treasurers, McCulley says, will need to weigh interest-on-checking offers from their banks against alternatives they have used in the past to earn interest on cash, such as having balances swept nightly into a money-market fund or offshore Eurodollar account. If they decide to leave cash with their bank, she adds, they’ll need to calculate how much additional counterparty risk they’re taking on as a result.

“Bank deposits are already at an all-time high of $1.3 trillion in corporate and commercial deposits,” McCulley says. “One of the lessons learned from the financial crisis of 2008–2009 was that companies had taken too narrow a view of counterparty risk.”

McCulley notes that the repeal of Reg Q and the increased FDIC and reserve-requirement burden on banks will complicate the bank service-fee model for corporations. The earnings credit in soft dollars historically applied to balances in lieu of interest may now look less attractive or different on a bank-by-bank basis. “Corporations and treasurers will have to look much more carefully at their account analysis statements. The ECR rates, interest rates, and FDIC fees will change and the mix applied to other balances will be more complex in this new era,” she points out.

Managing Credit Facilities

The Dodd-Frank Act requires that banks spin off their riskier derivatives activities into separately capitalized affiliates; this includes their commodity, agriculture, and energy derivatives businesses. This could complicate life for corporate treasurers on a seemingly unrelated front, the negotiation of bank credit facilities, warns Ann Svoboda, author of Actual Cash Flow and Americas treasurer for British confectioner Cadbury Plc until its recent acquisition by $40.2 billion Kraft Foods Inc.

“When you get credit and arrange your capital structure as a global corporation, you’re trying to divvy up which banks you get your credit from in relation to the services they provide,” explains Svoboda, who, as a member of the FEI Committee on Corporate Treasury, lobbied Congress as it drafted Dodd-Frank. “If banks need to segregate their services so that it is harder for them to provide you with what you need, that will make it harder for corporations to do the fee-for-credit calculation. That might result in having more counterparties, or in having different counterparties. It’s hard to know.”

What is likely, adds attorney Patrikis, are higher fees for lines of credit. “There is no free lunch,” he warns. “There are a lot of increased costs to banks because of Dodd-Frank, and these will have to be passed on to their customers.”

And Another Thing…

Some other notable components of Dodd-Frank include a revocation of the Reg FD exemption that has applied to credit-rating agencies. Millipore’s Kasok, for one, thinks it is going to cause grief for issuers of publicly traded securities. “I used to be able to have an open, blunt conversation with a rating agency, not because I was shopping for a rating but simply because they needed to understand my business,” Kasok says. “Now I can’t do that. I don’t know how a rating agency can properly evaluate and understand my business if I’m not able to have that conversation.”

The new law also requires the Federal Reserve to establish standards for interchange fees on debit-card transactions that are “reasonable and proportional” to the cost of processing them. These are the fees, usually ranging from 1% to 2%, that banks charge merchants for accepting debit cards. While it’s possible that the fees will be lowered as a result — the rule applies only to debit-card issuers with assets of $10 billion or more — it’s also possible that those issuers will seek to recoup the lost revenue through some other types of fees. “Virtually any company accepting major cards will be affected, potentially significantly,” says Ogilvie of the Deloitte Center for Financial Services.

The much-discussed Bureau of Consumer Financial Protection excludes merchants, retailers, auto dealers, and other sellers of nonfinancial goods or services, but only if they do not engage in offering or providing consumer financial products or services. It is not entirely clear whether that would bring under the bureau’s purview a retailer like $405 billion Wal-Mart Stores, whose in-store MoneyCenter sites provide services such as check cashing, money orders, money transfers, and bill payment, or a retailer that still issues its own credit card, such as $65 billion Target. (Wal-Mart did not respond to a request for comment.) A Target spokesperson said that because the Dodd-Frank Act is complex and relies heavily on regulations yet to come, it could not speculate about the impact on Target or its customers.

Given that companies can’t predict exactly how final rules will be written, Ogilvie also recommends that CFOs try to strengthen their relationships with their banks and other financial providers (see “Take Control of Your Bankers“), and take steps to improve their own company’s liquidity rather than relying on liquidity from banks.

“Ask yourself if you have access to enough additional capital to ride out the next economic downturn,” Ogilvie says. “And, obviously, worry about costs. Every company I’ve had anything to do with is examining every nickel and dime it spends to be sure it has to spend it, and that when it does spend it, it’s spending it as efficiently as possible. There’s a big emphasis on cost management, liquidity management, and capital management.”

In short, the Dodd-Frank Act’s negative consequences seem likely to reinforce practices that nearly all CFOs have already come to regard as the new normal. Whether it succeeds in preventing the sort of crisis that ushered out the old normal remains to be seen.

Randy Myers is a contributing editor of CFO.