Derivatives Directives

The High Cost of Hedging

Copper Wire DPA
EMIR regulations are stretching companies thin.
  • Why it matters

    Why it matters

    Companies dealing in volatile markets, like copper wire, have to hedge their investments. New E.U regulations on registering each and every transaction have burdened midsize businesses with bureaucracy.

  • Facts

    Facts

    • EMIR stands for European Market Infrastructure Regulation. It was enacted after the financial crisis to make trading in derivatives more safe and transparent.
    • Companies must prove that all derivatives are recorded in their entirety, are not being used for speculative purposes and have been registered and archived on time.
    • On average, the added cost of fulfilling the new rules for mid-sized companies is between €10,000 and €20,000.
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    Audio

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Complicated matters are not usually a problem for Ernst-Michael Hasse. The company he co-owns – Schwering & Hasse in the German state of North Rhine-Westphalia – manufactures enameled copper wire that is turned into all sorts of electrical equipment, from electric toothbrushes to windmills.

Mr. Hasse buys copper wire from suppliers around the world. At the company’s plant, the heavy wire is stretched out and then repeatedly enameled to insulate it for safe electricity conduction.

The 150-year-old family firm, now in the hands of the fourth generation, has been buying and selling copper for more than 60 years. Over the last 10 years, the copper market has been especially volatile, so an important part of the business involves hedging – a way of investing to offset possible losses or gains when prices go up or down.

“We hedge our position on the exchange to avoid risks,” Mr. Hasse said. “Today, when we sell copper to a customer, we have to make an offset transaction, both in dollar/euro and in copper. If we didn’t hedge, it would mean taking an irresponsible risk for our company.”

Without offset hedge trades, the company has revenues of €110 million ($140 million).

This is where European Union regulation on over-the-counter derivatives comes in – and Mr. Hasse says it’s driving him crazy. It’s called EMIR (European Market Infrastructure Regulation) and was enacted after the financial crisis to make trading in derivatives safer and more transparent.

The companies must reckon with price fluctuations between 10 and 15 percent over the year. So it makes sense to hedge.

If midsize companies are involved in commodities and safeguard their business through hedging, they are required to record all exchange transactions and report them to each partner in the transaction. In the case of Schwering & Hasse, there are 100 such transactions each week. Reporting them costs the firm a part-time employee plus registration fees for various listings, totaling about €2,000.

As a rule, banks gather the data and report it to the transaction registry. Mr. Hasse is sent a list of the transactions. Then the figures must be checked because the company is responsible for their accuracy. “When we do deals with brokers in London, we also have to gather the data ourselves and send it on to the transaction registry,” Mr. Hasse said.

Experts say the E.U. derivatives regulation amounts to “collateral damage for midsize companies.”  Most believe more medium-sized firms should hedge because many buy and sell volatile commodities. Even with the current decline in prices, the companies must reckon with price fluctuations between 10 and 15 percent over the course of a year. So it makes sense to hedge, even though now it is “much more complex and requires considerable attention,” said Martin Weibeler, an expert on derivatives regulation at Commerzbank.

Banks are affected, too, and Commerzbank has conducted about 40 information programs on the topic. Midsize companies with up to €100 million in revenues expect support from their banks, Mr. Weibeler explained.

“The bottom line is that on the day after the transaction, some 40 to 50 items must be entered to complete the appropriate transaction form,” he said. “All that paperwork doesn’t belong to the core business of a medium-sized company.”

The regulation carries added accounting costs as certified accountants also monitor adherence on EMIR for annual financial statements. In the case of Mr. Hasse, that adds up to another €10,000. On average, the added cost for mid-sized companies is between €10,000 and €20,000 and sometimes more, according to Christian Debus, an expert at the accounting firm KPMG.

 

“There are more decrees on the way and they will impose more regulations on the derivatives business.”

Martin Weibeler, Commerzbank

The fact that accountants are also involved is a German peculiarity. An insider who declined to be named explained why: “The German industry, which four years ago offered vehement opposition to EMIR, apparently preferred to be monitored by an accountant with business sense than by a government financial agent.”

The companies must prove to the accountant that all derivatives are recorded in their entirety, are not being used for speculative purposes, and have always been registered and archived on time. This is only possible through a corresponding IT infrastructure banks and businesses have to invest in. The accountants then have to conduct random checks and certify their accuracy to the German financial authority, Bafin.

“There were great difficulties at the beginning,” said Mr. Debus, noting that the transaction registry was overwhelmed by a flood of data from companies. “Now things are going better, but there are still challenges here and there.”

Medium-sized businesses have another problem with E.U. derivatives regulation from Brussels. “Nobody knows what is supposed to happen with that tangled mass of data,” said Mr. Hasse, describing EMIR as an “utterly senseless bureaucratic make-work program and a paper tiger with reference to the financial crisis.”

For now, financial experts doubt the reporting regulations will be reconsidered. “On the contrary,” said Mr. Weibeler of Commerzbank. “There are more decrees on the way, and they will impose more regulations on the derivatives business.”

 

Anja Müller covers medium-sized businesses for Handelblatt. To contact the author: mueller@handelsblatt.com

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