Corporate treasurers whose companies use over-the-counter (OTC) derivatives to hedge interest rate, currency, or commodity exposures will want to look closely at reforms to the market now under consideration in Washington. A report issued by the Department of the Treasury titled “Financial Regulatory Reform: A New Foundation: Rebuilding Financial Supervision and Regulation,” contains a number of proposed changes to the U.S. financial regulatory system. Among them is “comprehensive regulation of all over-the-counter derivatives.”

Although it seems to have gone pretty much unnoticed among corporate financial types, the proposals would affect more than just banks and financial institutions, says Jiro Okochi, chief executive officer and cofounder of Reval.com, Inc., a provider of derivative risk management and hedge accounting solutions. “Awareness seems low,” Okochi says. “Corporations think it’s all about banks and credit default swaps.”

That’s not the case, Okochi says. Among the proposed changes that could directly impact corporate users of derivatives are calls for recordkeeping and reporting requirements on all OTC derivatives, and a requirement that “all standardized OTC derivative transactions to be executed in regulated and transparent venues and cleared through regulated central counterparties,” or exchanges. In addition, the report proposes “to harmonize the statutory and regulatory regimes for futures and securities.”

The intent of the proposed reforms is, of course, to reduce the incidence of systemic risk in the markets and to prevent fraud and abuse, while also averting future financial crises. In reality, however, the proposals could impose costs on companies that did nothing to contribute to the financial mess we’re currently working through, Okochi says.

For starters, moving standard OTC derivatives to an exchange would force companies that currently use these to incur margin costs. Moreover, it prompts the question: Just what are standard trades? Both companies and regulators could end up spending a great deal of time and energy wrangling with this question. And, the change could encourage companies to create nonstandard derivative transactions in order to avoid conducting the transaction on an exchange.

Okochi instead advocates exempting from the proposed requirements any derivative transactions that already qualify for hedge accounting treatment under FAS 133 or IAS 39. He wrote in a June 17 letter to the Secretary of the Treasury that these “are not the derivatives that were used to create the leverage that caused considerable stress on the financial system.” At the same time, “exempting OTC derivatives that qualify for hedge accounting under existing standards will aid reform efforts by encouraging risk management, eliminating potential loopholes, promoting transparency, and eliminating the time and expense of designating trades as either standardized or nonstandardized trades.”

At least one corporate derivatives user, 3M, has commented on the impact potential changes could have. “We urge policy makers to preserve commercial users’ access to existing derivative products as you design new regulations,” wrote Timothy Murphy, foreign currency risk manager with 3M, in a June address to the House Financial Services Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises. He went on to say that the company opposes a mandate to move all OTC derivative transactions to exchanges.

More information on the proposed changes, including Congressional testimony, the Treasury’s report, and 3M’s address, can be found at www.savemyswaps.com, a microsite launched by Reval. ###