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New Legislation Could Affect REITs' Risk Management

07/23/2009 | By Allen Kenney

New Legislation Could Affect REITs' Risk Management
Congress currently is considering legislative measures to regulate financial derivatives that could significantly impact how REITs hedge risk.
 
Among the proposals under consideration are mandating trading exchanges or creating a central clearing house for all "over-the-counter" derivatives (OTCs). OTCs are products customized to fit individual business' unique risk management needs.
 
The energy bill that gained House approval in June included language that would institute a clearing house program for derivative products. Under this type of program, a third-party intermediary would intervene in derivative transactions, guaranteeing performance and payments. This clearing house would require the entities involved in the transaction to post initial cash collateral, adding to that amount as market conditions change.
 
A trading exchange would serve as a public market and would include all of the clearing house's same features. However, exchanges typically support highly standardized contracts that are traded in high volumes.
 
As part of wider financial regulatory reform efforts, Congressional leadership and the White House currently are working on new legislative language that is expected to replace the measures contained in the energy bill. NAREIT has joined other industry groups to address the concerns related to maintaining the ability of businesses to use derivatives to manage risk.
 
Representatives from risk-management consulting firm Chatham Financial Corp. have been meeting with legislators and federal regulatory agencies to discuss the impact of the proposals on firms that use OTCs as part of their financial planning. In a letter to Congress, J. Michael Bontrager, Chatham's president and CEO, warned that the collateral requirements being proposed to underwrite derivatives contracts could deter firms from using OTCs to manage risk. Also, he noted that under an exchange, firms could lose the ability to construct highly customized products to hedge their risk exposures.
 
"We have substantial concerns that an indiscriminate implementation of any new regulatory framework could have unintended consequences that effectively deprive U.S. businesses of the ability to use OTC derivatives to mitigate the risks they face in the normal course of business," Bontrager wrote. "New regulations should focus on the participants in the OTC derivatives market that are large enough to pose a risk to the financial system."
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