The greenback's dramatic across-the-board depreciation over the past year has pushed corporates' foreign exchange hedges in or out of the money and because of the size of these positions banks are increasingly pressurizing clients to post collateral.
Treasurers, however, are resisting the move because the credit support annexes that govern collateral have the potential to put a company's liquidity under pressure. In the event of an adverse market move, they argue, corporates may suddenly have to put large amounts of cash behind trades. In addition, there is limited upside for corporates because rating agencies do not give corporates credit if they are receiving collateral from the banks, but will penalize corporates that have collateral tied up in these trades. One advantage, however, is the credit support annex would protect the corporate against a default by the derivatives counterparty, but this is seen as unlikely because most derivatives counterparties are highly rated.
The topic has sprung to prominence following ScottishPower's recent decision to re-price around half of its in-the-money cable swaps portfolio, a move in which it clocked up a GBP400 million (USD735 million) windfall. The move was partly motivated by the fact that ratings agencies were not taking the off-balance sheet gain into account, according to treasurer Adrian Coates. "Credit support annexes are a double-edged sword," he added. Although they hedge the corporate's exposure to a counterparty, if the swaps had been the other way round, the corporate would have had a GBP800 million liability and posting collateral would have had a severe effect on cash-flow, noted Coates.
Emanuel Dubois-Pelerin, credit analyst at Standard & Poor's in Paris, noted, "We always look at collateral agreements as part of our liquidity analysis, but it is true we look more at the corporate's negative collateral than any positive collateral they may be receiving." One banker exclaimed, "They tell corporates to be concerned about liquidity, but tell banks to get collateral."
"We encourage corporate customers to enter credit support annexes, and we may offer better terms if collateral is provided," said Robert McWilliam, head of counterparty exposure management at ABN AMRO in London. Regulations such as International Accounting Standard 39, however, which require off-balance sheet derivatives to be marked to market, will likely clarify some of these issues for corporates, he added.
