September 27, 2012 / 5:56 PM / 5 years ago

EU watchdog backs down on stock option hedging

LONDON (Reuters) - Companies will not be penalised for using derivatives to “insure” their stock option plans under final European Union rules to make the $650 trillion market safer and more transparent.

World leaders agreed in 2009 that derivatives should be centrally cleared and recorded to provide the kind of snapshot of positions that regulators lacked when dealing with the collapse of U.S. bank Lehman Brothers in September, 2008.

The reforms are being introduced next year and the European Securities and Markets Authority (ESMA) published its final rules with some key tweaks after opposition from the industry.

The bulk of derivatives are traded among banks but companies such as airlines and manufacturers also them to hedge against risks.

ESMA had proposed that companies who wanted to hedge employee benefits such as stock option plans could not be treated leniently. It has now backed down in a move corporate treasurers across Europe will welcome.

“In its standards, ESMA clarifies that employees’ benefits, such as stock options, and acquisitions would be covered by the hedging definition,” the watchdog said in a statement.

Using derivatives for such activities will not count towards calculating whether a company uses derivatives enough to require its transactions to be centrally cleared, a costlier process that requires margin and collateral.

Corporate treasurers had argued it was routine practice to use derivatives to cover themselves against risks from operating expenses linked to pension and employee plans.

“We very definitely welcomed the fact they have clarified that stock options will come within the hedging definition,” said Martin O‘Donovan, deputy policy and technical director at the Association of Corporate Treasurers (ACT).


Companies will have to clear all their derivatives trades even if only one type of derivatives asset goes above the threshold, a disappointment for the ACT.

The thresholds have been set at between one and three billion euros in outstanding contracts, the figure depending on the asset in question.

“The good news is that the thresholds are still reasonably high so the number of companies that will be affected is quite limited,” O‘Donovan said.

But ESMA’s rules must be formally endorsed by the EU’s executive European Commission, and the bloc’s member states and European Parliament can also ask for changes.

The political impetus has been for low thresholds to trigger mandatory clearing so corporate treasurers remain nervous of last minute changes, O‘Donovan said.

The watchdog gave energy markets a temporary carve-out from having to post margin on derivatives trades.

ESMA also gave major relief to clearing houses by halving the minimum amount of capital they should hold in case of a default among their members.

Due to delays in rulemaking at the global level, ESMA had to leave out a crucial section on how much margin market participants must pay on uncleared derivatives trades - a cost that will determine where some contracts are executed or not.

The new rules will come into force in early 2013 though regulators say it would take several months to begin enforcing some elements such as reporting requirements and deciding which types of derivatives contracts must be centrally cleared.

Editing by David Cowell and Mark Potter

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