Chatham’s Clark Maxwell, Steve Castleton, and Razvan Ionescu analyze shortcut and long-haul methods as they relate swapping fixed-rate debt to floating. In spite of the accounting complexities involved, the authors show that such allocations of debt can be beneficial and in line with a company’s economic objectives.
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Proposed EU rules on derivatives could take an estimated EUR 64.9 billion of working capital away from Europe’s real economy as property businesses risk being required to collateralize their interest rate hedges with cash. This is the main conclusion of a Chatham Financial study commissioned by the European property sector to assess the impact of the European Commission’s proposed European Market Infrastructure Regulation (EMIR) released on September 15, 2010.

One of EMIR’s core requirements is that businesses deemed to be ‘financial’ entities must centrally clear their hedges and post cash collateral to a central clearing party. ‘Non-financial’ businesses, which use derivatives for hedging commercial risks are rightly excluded from these requirements. Absent legislative clarification, property businesses (which use interest rate hedges to protect against fluctuating interest rates), risk being misclassified as ‘financial’ entities and thus subject to onerous clearing requirements which would undermine the stability of the property and banking sector as well as diverting precious capital from the real economy.
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After more than a year of political and legislative wrangling over the Alternative Investment Fund Managers Directive (“AIFMD”), the EU Parliament finally adopted the Directive in its plenary session last week by a vote of 513 to 92 with 3 abstentions. This brings the regulation of a broad range of funds (hedge funds, private equity, real estate, microfinance) one step closer to implementation. There remains a degree of uncertainty as ESMA – the new EU financial super-regulator, the EU Commission, and EU member states will need to work through important implementation guidelines from now until the effective date of 2013.
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We recently provided our views to the FASB on its controversial proposal to modify the accounting for financial instruments, including revisions to the accounting for derivatives and hedging activities. With respect to financial instruments in general, we continue to believe that both fair value and amortized cost have merit, and we share the concerns of most constituents that the FASB proposal goes too far with fair value as the primary measurement attribute for nearly all financial instruments.

As for derivatives and hedging, we agree with certain provisions of the proposal, including reducing the standard for hedge qualification from “highly effective” to “reasonably effective.” However, we have serious concerns about the FASB’s proposed prohibition against removing the designation of an effective hedge (no more de-designations) and the substantial transaction costs that would be incurred by companies to “fully offset” such positions in the marketplace to achieve an “effective termination” under the new rules.

We also think the FASB is missing a golden opportunity to significantly simplify/improve the hedge accounting model and further converge with IFRS. In particular, we would like to see the FASB permit companies to hedge any “separately identifiable and reliably measurable” portion or component of a financial instrument’s cash flow or fair value (for example, permit non-benchmark-rate indices like Prime and Fed Funds to be treated similarly to a benchmark rate like LIBOR). Without going into detail, this provision also would significantly simplify the accounting for fair value hedges of fixed-rate assets and liabilities–and even provide a reasonable approach for hedges of callable debt. We also would like to see the FASB permit bifurcation-by-risk for identifiable and measurable components of nonfinancial items.
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After more than a year of incubation, the European Commission finally released a draft proposal of its derivatives legislation on September 15th, 2010. By and large, the proposal harmonizes with the U.S. Dodd-Frank bill with several notable exceptions including classification of companies into regulated and exempt entities.

The EU derivative regulation works in conjunction with several other pieces of EU legislation including the AIFM, CRD, and MiFID to form a comprehensive regulatory framework. The AIFM and the derivative regulation proposed today are still subject to final approval in the EU. While the CRD and MiFID are subject to review and potential revisions to bring them in line with the G20 spirit of more regulation for the derivatives market.

Although, the final shape and form of European derivative regulation will not be known until the end of 2012, the broad principals and outlines are in place and clients would benefit from understanding and preparing for the coming regulatory changes that could have significant impact on their business. Download Now 

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, an historic piece of legislation that will enact the most sweeping set of rules for the financial services industry since the 1930s. Following is a summary of one of the sections of the legislation that specifically deals with regulation of over-the-counter (OTC) derivatives. The summary is intended to be used to understand the key elements of the derivatives title and can be used as a quick reference guide for market participants. Download Now 

Early Friday morning, negotiators for House and Senate reached a compromise on the OTC derivatives bill. The “conference report” which reflects this compromise will be sent next week to the House and Senate to be voted upon. It is expected to pass and be signed into law by the President not later than July 4th. The differences between the bills were negotiated through the night. Though it was televised on C-SPAN, many of the amendments were not made available to the public, including the final House “offer” that contained last minute changes. As such, many of the items below are subject to confirmation upon review of the actual language. Download Now 

Jason Hoffnagle, Managing Director at Chatham Financial for the Asian Office is featured in an article in the June 2010 issue of AsiaProperty. He addresses the misconception that hedging is a complex and risky business that prevents many property investors from using it as a tool to protect themselves against possible losses resulting from currency fluctuations in cross-border deals.  Download Now 

This Op-Ed by Chatham’s Luke Zubrod on FT.com evaluates the unintended consequences of the controversial swaps desk spin-off provision by analogy to Hawaii’s 19th century introduction of the mongoose as a solution for rat infestations that threatened its sugar crop. Download Now 

European policy makers have joined those in the UK in asserting that manufacturers, energy producers and hospitals should not be subject to the same derivatives regulatory regime as large financial institutions. At the same time, the Obama administration has said that it would “fight hard to oppose” provisions that clearly differentiate such companies – known as “end users” – from the likes of AIG and Goldman Sachs. So it begs the question: “What does Europe know about derivatives reform that the White House doesn’t?” The answer: European policy makers have been listening to hundreds of corporate treasurers from companies like Lufthansa and Caterpillar and to the European Association of Corporate Treasurers, who have told them of the great harm that would result from indiscriminate application of derivatives regulations. Download Now 

In addition to the market transparency that would be provided by central trade repositories, CFTC Chairman Gensler is proposing that the vast majority of OTC derivatives be required to trade on regulated “swap execution facilities” (“SEFs”). Examples of SEFs include electronic trading platforms such as FXall and Tradeweb. Download Now 

Second part of a two part series describing the economic settlement of derivative contracts after a bankruptcy event. Download Now 

First part of a two part series describing the treatment of derivative contracts during bankruptcy. Download Now 

Arguably no other accounting standard has received so much attention in recent times as Statement of Financial Accounting Standards No. 157 ‘Fair Value Measurements’ (ASC 820, and formerly FAS 157). This article explores the application of ASC 820 on derivatives financial instruments, and showcases the importance of consider the nature of such financial instruments when calculating adjustments for credit risk. Download Now 

An introduction to Swap breakage concerns within the struggling CMBS industry.
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Find out why defeasing a loan in today’s market can make sense.  Download Now 

Today’s hedging strategy can include standard derivative instruments such as interest rate swaps, caps, or collars. However, navigating the hedging decision is no simple matter and depends not just on company or business specific factors, but also on conditions in the market at the time the strategy is implemented. This article explores important factors to consider when navigating the interest rate hedging decision.  Download Now 

A brief discussion on hedging options for new financing and how the analysis can be impacted by a defeasance requirement. Download Now 

An indepth look at the difference between Yield Maintenance and Defeasance provisions and how different market conditions impact the cost of each.  Download Now