January 24, 2013 
Catchy headline, nice story, the CFO of RR explains why making firms who don’t represent a systemic threat to the world financial system should be left alone. Click for story, free access.
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Bill Hodgson
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Though small in notional terms it is not true to say that corporations trading derivatives are immaterial to the systemic counterparty risk equation because:
- a corporate’s OTC portfolio with a bank would usually be directional (i.e. they are hedging rather than trading a flat OTC derivatives book in the manner of a market maker)
- frequently a corporates relationship revenue from another source (e.g. investment banking / primary market operations) leads banks to accept relatively loose collateral terms (no initial margin, sometimes no variation margin)
As a result corporates as a client segment may be as much as a 1/3 of a banks OTC counterparty tail risk even if their proportion of open trade notional or current counterparty exposure is less than 10%.
The corporates portfolios in aggregate can result in significant risk, margin funding costs and capital charges (both under Basel II and Basel III) especially when considering that a pure flow trading dealer will hedge the corporates portfolio market risk with another dealer (with attendant initial margin / Basel III capital charges) or with futures (with attendant cleared / Basel III capital charges)
Given the political power of corporations has led to exemptions from Dodd-Frank and EMIR risk mitigation approaches (clearing, bilateral initial margin) but Basel III applies to all of a bank’s counterparty risk, corporates will increase from already significant proportion of the total risks and capital usage of a bank through the initial regulatory transition and as legacy portfolios (unmitigated by new regulatory margin) with financial counterparties roll off and new trades with financials are mitigated.
In my view there is no financial logic supporting corporate exemptions whatever the political logic is. In any case, in particular the CFO of Rolls Royce cannot rationally expect to both have the exemption and be immune to the natural passing on of increased costs of that exemption to their counterparties.