European buy-side firms remain uncertain about classing themselves as hedgers or speculators under Commodity Futures Trading Commission (CFTC) rules governing swaps trading for users of futures commission merchants (FCMs).
The CFTC’s derivatives clearing organisation (DCO) final core principles state customers of FCMs are required to identify which of the two category they fall in to based on their entire portfolio, rather than at transaction level. Speculative clients are required to pay 10% in CCP calculated margin compared to hedging clients.
The hedger/speculator concept is common to futures markets, where participants are able to identify on a trade level whether each transaction is hedging or speculative in nature. In the OTC derivative market, the margin methodology is portfolio based, so firms must decide whether all of their derivatives transactions are hedging or not.
One UK buy-side executive speaking anonymously to theTRADEnews.com said both regulators and clearing brokers had not offered necessary clarity, forcing buy-side firms to take a conservative approach and define themselves as speculators. Many are choosing the hedger option, some of whom fear they may face a fine at a later date.
“We’re still waiting on further clarity on this from our clearing brokers,” the source said. “No one is keen on speaking about this issue, because there is a fear if regulators begin to look at it, then most asset managers will be required to pay the higher margin costs.”
Sell-side firms are similarly in the dark on the rules and have been forced to advise clients in broad terms, with the caveat that asset managers must make their own decision on which option to select.
“There has been a lack of regulatory clarity surrounding buy-side firms defining themselves as speculators or hedgers under their clearing agreements,” Mariam Rafi, Americas head of OTC derivatives clearing and intermediation, prime finance for Citi, said.
“From an FCM perspective, we request that clients make their own decision on which category they fall into.”
Rafi said US buy-side firms had grappled with the issue in May 2012, when the rules initially came into force, but said a number of firms had continued to ask for clarity from brokers.
She added that European asset managers were still uncertain about which category they would fit into, and were continuing to request advice on the issue.
“Despite higher margin requirements, some asset managers are taking a conservative approach to the rules and defining themselves as speculators.”
Detail on the rules was initially published in the federal register in November 2011, stating that hedge positions would include all swaps that hedge or mitigate any form of a customer’s business risks, including those from financial or non-financial entities.
Swaps classed as hedging positions would include those that substitute for transactions to be made or positions to be taken at a later date, where they are economically appropriate to the reduction of risk, the Commission’s text in the register stated.