81,912
edits
Hedging exemption: Difference between revisions
Jump to navigation
Jump to search
no edit summary
Amwelladmin (talk | contribs) No edit summary |
Amwelladmin (talk | contribs) No edit summary |
||
| (4 intermediate revisions by the same user not shown) | |||
| Line 1: | Line 1: | ||
{{a|repack|}}[[EMIR]] regulates the infrastructure of European financial markets, and one of its main jobs is to mandate the exchange of [[Variation margin|variation]] and [[initial margin]] for [[Uncleared derivatives margin - EMIR Provision|uncleared derivatives]] — a sort of cack-handed [[behavioural psychology]] play to nudge OTC derivatives trading onto exchange. Hasn’t worked. Anyway, we digress. | {{a|repack|{{image|delta-hedge|jpeg|A [[delta hedge]] yesterday.}}}}[[EMIR]] regulates the infrastructure of European financial markets, and one of its main jobs is to mandate the exchange of [[Variation margin|variation]] and [[initial margin]] for [[Uncleared derivatives margin - EMIR Provision|uncleared derivatives]] — a sort of cack-handed [[behavioural psychology]] play to nudge OTC derivatives trading onto exchange. Hasn’t worked. Anyway, we digress. | ||
Posting cash to a counterparty for mark-to-market moves is a painful, and [[When variation margin attacks|in some respects, stupid]] thing to do, and market participants are not well set up to do it, others for which the scale of their trading means it is not worth the bother — and many for which both is true. These are the so-called “[[Non-financial counterparties - EMIR Provision|non-financial counterparties]]” — businesses not designed primarily for the financial services industry, and whose incidental activity in OTC derivatives markets does falls below [[EMIR clearing thresholds|specified thresholds]]. | Posting cash to a counterparty for mark-to-market moves is a painful, and [[When variation margin attacks|in some respects, stupid]] thing to do, and some market participants are not well set up to do it, others for which the scale of their trading means it is not worth the bother — and many for which both is true. These are the so-called “[[Non-financial counterparties - EMIR Provision|non-financial counterparties]]” — businesses not designed primarily for the financial services industry, and whose incidental activity in OTC derivatives markets does falls below [[EMIR clearing thresholds|specified thresholds]]. | ||
Non-financial firms whose derivative activity falls below those thresholds are labelled “[[NFC-]]” and are out of scope for EMIR [[regulatory margin]]. | Non-financial firms whose derivative activity falls below those thresholds are labelled “[[NFC-]]” and are out of scope for EMIR [[regulatory margin]]. | ||
===[[EMIR]] “Hedging exemption”=== | ===[[EMIR]] “Hedging exemption”=== | ||
The question may arise as to whether an SPV is a [[non-financial counterparty]] and, if it is, whether article {{emirprov|10.3}} of EMIR means you don’t have to engage in all that tedious measuring of notionals to ensure you stay small enough to count as an [[NFC-]]. Here’s what the [[hedging exemption]] says: | The question may arise as to whether an SPV is a [[non-financial counterparty]] and, if it is, whether article {{emirprov|10.3}} of EMIR means you don’t ''have'' to engage in all that tedious measuring of notionals to ensure you stay small enough to count as an [[NFC-]]. You can do that as long as you are only trading derivatives to hedge your commercial activities; that your swap activity positively ''reduces'' the risk inside your organisation. | ||
{{quote|3. In calculating the positions referred to in paragraph 1, the [[non-financial counterparty]] shall include all the OTC derivative contracts entered into by the non-financial counterparty or by other non-financial entities within the group to which the non-financial counterparty belongs, which are not objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of the non-financial counterparty or of that group.}} | |||
Here’s what the [[hedging exemption]] says: | |||
{{quote|3. In calculating the positions referred to in paragraph 1, the [[non-financial counterparty]] shall include all the OTC derivative contracts entered into by the non-financial counterparty or by other non-financial entities within the group to which the non-financial counterparty belongs, which are not objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of the non-financial counterparty or of that group.}}Now you might think this is an open-and-shut question: ''what is a hedge''? Surely if you have liabilities in one currency, or rate, or linked somehow to one kind of financial indicator, but your income is denominated in another, and the point of your swap is to match one with the other, then it is a hedge, right? | |||
===Repackaging SPVs=== | ===Repackaging SPVs=== | ||
There are two ways of | And there is no better, cleaner, paradigmatic example of an entity that uses OTC derivatives to match income to outgoings than a [[Secured, limited recourse obligation|secured, limited recourse]] [[Repackaging programme|repackaging]] [[Special purpose vehicle|SPV]]. This is ''literally'' what a [[Repackaging|repack SPV]] does with OTC derivative: no more; no less. Yet, at least according to one [[Magic circle law firm|magic circle]] [[law firm]],<ref>Which shall remain nameless</ref> the matter is “not free from doubt”. Yet, this firm struggles to explain the doubts it has: when you prod or poke at them, they tend to dissolve, like nasty toilet paper, at just the point where you might have wanted them. | ||
“A [[credit-linked note]], you see, doesn’t so much hedge a note, as the note hedges ''it''.” | |||
“Are you serious?” | |||
“... But the [[better view]] we think is, ah, it probably ''is'' a hedge. Perhaps a [[credit-linked note]] is not the best example.” | |||
“So what ''is'' the best example?” | |||
“[[I have to hop]].” | |||
We wonder whether the firm might have committed itself to an outcome which on hindsight it realises is a bit potty, but polite comportment means it might now be a bit difficult to reverse-ferret out of. | |||
In any case it seems to us that the idea a repackaging SPV is ''not'' hedging, ''by definition'', with ''any'' properly-structured<ref>By which I mean it has effective, standard limited recourse terms and has been competently drafted to achieve the intention of overall transaction.</ref> [[OTC derivative]] it enters, is a faintly preposterous one. Vigorously preposterous, in fact. | |||
There are two ways of arriving at this conclusion: one is via a purposive approach, the other, a literalist one. Now financial services professionals and ''[[a fortiori]]'' their advisers are a profoundly literal, formalist bunch, so they lean hard into nuanced questions such as “would this qualify for hedge accounting under IFRS?” or “can we say this is directly reducing risks directly relating to the financing activity of the SPV?”, but struggle to stand back and look at the bigger picture. If they did, they might say “imposing a cash margining arrangement with a secured, limited recourse SPV makes no sense at all”. | |||
====The formalist argument==== | ====The formalist argument==== | ||