The Costs (If Any) of Derivatives Reforms

The question of the impact of derivatives rules on ‘end users’ — real economy companies who use derivatives to hedge production risks — has been a constant refrain in derivatives debates.  The claim is that basic requirements to back up derivatives with cash collateral (such as clearing and margin requirements) will impose large costs on end users. These arguments about a supposed burden on real economy companies have already led to a broad exemption from derivatives clearing requirements for non-financial end users. But opponents of new derivatives rules are continuing to push the idea that any kind of margin requirements (including for uncleared derivatives) would create significant economic costs.

Now John Parsons of the Massachusetts Institute of Technology has written the definitive paper on just how small – or possibly non-existent – the costs of new margin requirements will be. The major point of the paper is that the costs of derivatives exposures are inherent in the risks being taken in the derivative. Requirements to temporarily reserve money in margin or collateral accounts against possible future exposures don’t affect those costs, they simply change the form in which they are recognized. Unmargined derivatives are in effect a loan to the company. Reserving money up front means that the company recognizes its risk earlier, and in a more transparent fashion.  These are simply good risk management practices, not new costs. They do change cash flows and the timing of payments. But these changes in the timing of cash flows should have at most a small effect on true costs.

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