The Obama administration has put forward a plan that would cause a paradigm shift in the world of over-the-counter (OTC) derivatives.
According to an announcement by Treasury Secretary Timothy Geithner, the plan would mean that all standardized derivatives would be cleared through a central clearing house. These derivatives would also no longer be over-the-counter, instead traded on electronic exchanges, and usher in regulation to a USD450 trillion market that has largely been unregulated.
Geithner, Securities and Exchange Commission Chairman Mary Schapiro, and Mike Dunn, acting chairman of the Commodity Futures Trading Commission, are behind the move.
Predictably, exchanges are lending their support to the idea. NASDAQ OMX today voiced their commitment to the proposal, with Bob Greifeld, CEO, stating: “It is a win-win for investors, market participants and banks.”
NASDAQ OMX is the majority owner of the International Derivatives Clearing Group, which is an approved Commodities Futures Trading Commission regulated clearinghouse for OTC interest rate swap futures contracts and other fixed income derivatives contracts.
Others were not so supportive. The Wholesale Market Brokers Association (WMBA), an independent industry body based in the UK representing the worlds largest Inter-Dealer Brokers, released a statement expressing disappointment that the US Treasury Department did not take into account the reality that most of the severe losses suffered by banks occurred in the structured credit markets and not in the OTC CDS [credit default swaps] market.
According to David Clark, Chairman, WMBA: The WMBA wishes to warn again that forcing OTC products onto exchanges would significantly reduce liquidity in financial markets, resulting in increased risks and costs for end users as their ability to hedge their exposures would be handicapped.
WMBA voiced its concern that some policy makers do not seem to acknowledge that making markets more secure can be achieved through the clearing of products through recognized central counterparties (CCPs). WMBA has previously supported moves for efforts to clear CDS through CCPs as well as other financial products that are suitable or relevant for clearing, but draws the line at the need of regulators to coerce OTC products onto exchanges.
A recent paper commissioned by the City of London Corporation also urged regulators not to throw the baby out with the bathwater regarding increased regulatory and clearing requirements.
According to the paper written by Bourse Consult, 43% of the value of OTC derivatives is traded in London, with only 24% in the US.
GFI, a broker that would be hit hard by the realization of Geithners proposals, issued an ambiguous statement following the announcement by the US Treasury. Chairman and Chief Executive Officer, Michael Gooch said: “GFI has long advocated greater transparency, central counterparty clearing, contract standardization and use of electronic trading for OTC derivatives. We believe that, if properly implemented, these initiatives will help in the recovery of the financial markets.
Michael Gooch continued: “I believe that the standardized OTC derivatives markets will evolve similarly to the markets we now see in equities, equity derivatives and energy derivatives, where GFI currently crosses trades over the counter both electronically and via broker assistance and posts those trades for central counterparty clearing.”
If anything, GFI seemed resigned to the changes, stating: GFI is well placed to benefit from more transparent, electronic markets for OTC and listed derivatives.
Brokers such as GFI, Tullet Prebon, BGC and ICAP are not suffering as much as other financial sectors. Tullet Prebon recently released its Q1 results, with revenue up 10% year-on-year at GBP354 million, due to volatile markets and demand for government bonds.
Brokers are also looking pre-empt OTC regulation, with ICAP leading a consortium of bidders for clearing house LCH.Clearnet. It seems undeniable that OTC derivatives will see increased clearing demands. If so, LCH.Clearnet, which clears for the London Stock Exchange, would be a primary benefactor of any new regulation.