New regulations on banks and swaps markets could increase derivatives transaction costs, causing companies to reduce their hedging activity and assume more risk from direct exposure to commodities, says Greenwich Associates in a new report.

The firm says that while corporate users of derivatives are sheltered from the direct impact of new regulations, such as the Dodd-Frank reform in the U.S. and the Basel III reforms worldwide, by so-called ‘end-user exemptions’, these rules will change the economics of the commodities derivatives business for banks. In particular, it says that increased capital costs associated with new reserve requirements will have a significant impact on these businesses. Additionally, changes in derivatives rules will make it more expensive for banks to hedge their own risks, and will force them to incur the “substantial costs” of developing and operating required trading infrastructure.

“For banks that specialize in these products, these rising costs will eat into overall returns on equity, already substantially down from pre-2008 levels,” it says. “These changes could prompt some large banks to exit the commodities derivatives market or scale back, which would limit competition and narrow companies’ choice of dealers.”

And, it says that this will “almost definitely raise transaction costs for companies looking to hedge energy and other commodities exposures.”

Greenwich reports that, on a global basis, companies now hedge 53% of their commodities exposure financially, down from 56% in 2009. “The likely result of regulatory changes is that corporates, facing higher costs to hedge, will hedge less and risk their own income statements,” says Greenwich Associates consultant, Andrew Awad.

Greenwich says it does not expect to see a change in how companies execute their hedges, although it notes that companies are expecting to increase the proportion of their business done on a centrally-cleared basis.

“What’s really interesting is that contrary to expectations, a full 25% of corporates want to increase their trades on a centrally-cleared basis even though they don’t need to do so and they would also incur margin costs,” says Awad. “What’s possibly driving this is credit capacity. Unsurprisingly, the highest proportion of these companies is in the oil and gas sector where derivative volumes are highest.”

The firm also reports that delays in enacting the final rules may have some companies hoping that they will not be affected. At least half of those interviewed by Greenwich have that expectation, it reports.

“That reflects the uncertainty in the marketplace as to the implementation of the rules, but it also reflects a bit of a lack of reality,” said Awad. “There will be an impact, but it may be a delayed impact. Those who think the regulations won’t have much effect on their operations have their heads in the sand. Just because the regulations officially focus just on financial institutions it does not mean corporates won’t feel some pain.”