Regulation of OTC Derivatives: CME, ICE to Benefit

By Neena Mishra

Last evening, the Treasury unveiled its proposal for a comprehensive regulatory framework for all Over-The-Counter (OTC) derivatives. The details of the proposal can be seen here.

These OTC derivatives, include credit default swaps that caused the near-collapse of AIG (AIG) and led to the $180 billion government bailout of the company. These derivates have largely remained largely outside the regulatory framework, though their market has exploded in recent years.

Among other things, the proposals mainly require all derivatives to be centrally cleared through regulated central counterparties (CCP) and all OTC derivative dealers (having large exposures) to be subject to capital and reporting requirements.

The proposals intend to make the trading of derivatives more transparent and also give regulators the ability to limit the amount of derivatives that any company can sell or hold.

The roots of the current problem go back to December 2000 when the Commodity FuturesModernization Act was adopted, which made the derivative instruments largely unregulated. The law came about after heavy lobbying from the bankers on the Wall Street.

The derivatives market which was relatively small then has since exploded and the face value of all derivatives contracts outstanding at the end 2008 totaled more than $680 trillion. In view of the enormous size of the market and the threat these instruments pose to the financial system, their regulation is long overdue.

We anticipate exchanges like CME Group (CME) and Intercontinental Exchange (ICE) to benefit from the new regulations.

Comments

[benjaminwright:]

Treasury Secretary Geithner is calling for new record-keeping requirements for what he calls "non-standard" derivatives. Part of the issue with the recordation of derivatives is that technology (e-mail, text message and so on) has made the formation of legally-binding contracts (such as derivatives) very cheap and easy. Efforts to promote better documenation on derivatives will provoke massive new campaigns to capture, archive and comprehend electronic financial records. See Details: legal-beagle.typepad.c... --Ben

May 14 12:59 PM

[Heaven, Hel...:]

>> The derivatives market which was relatively small then has since exploded and the face value of all derivatives contracts outstanding at the end 2008 totaled more than $680 trillion. In view of the enormous size of the market and the threat these instruments pose to the financial system, their regulation is long overdue. <<



One needs to be careful and not lump all OTC derivatives together, which you appear to be doing. For example there is a big difference between credit default swaps and interest rate swaps (which comprise approx. 2/3 of the OTC derivative market) and the systemic risk which they pose to the financial system (IRS payoff and risk profiles are much different than CDS).

May 14 04:02 PM

[cretin snif...:]

Regulation doesn't work for porn and we have the greatest porno industry in the world. Our derivatives markets just need to go back to the pre-Lehman regulatory climate and things will be swell again. People will see that regulation is boring and Americans are adventurous, and they will want to see what happens when the cowboys ride into town, so we'll have a repeat of the Fall '08 markets again. Volatility will spike and we'll all get rich and drink and do porn after school.

May 14 08:24 PM

[Andy1234:]

Regulation is the market bankrupting the losers.

I mean....why do we even have half of these regulations....like the FAA-PMA or FDA.

I would seriously think that its in the companies best interest to keep planes flying safely.....otherwise they are going to get sued like hell or people will stop buying/flying their planes if they crash.

That goes for anything and everything thats made........The regulations itself is a HUGE inefficiency and is not needed. Just MO.

May 15 08:44 AM

[ain't no fo...:]

Too many companies think it is in their best interest to make as much money as they possibly can, and they are more than willing to cut corners wherever they think they can get away with it in that pursuit. And they hire plenty of lawyers and marketing/PR staff to deny any wrongdoing in that regard. People die that way, or are grievously injured.

That is why you regulate companies and industries, because if you are too naive to understand that companies are out for one thing, and that is too make monstrous profits while they deny liability, then you are likely to be the one injured at some point.


On May 15 08:44 AM Andy1234 wrote:

> Regulation is the market bankrupting the losers.
>
> I mean....why do we even have half of these regulations....like the
> FAA-PMA or FDA.
>
> I would seriously think that its in the companies best interest to
> keep planes flying safely.....otherwise they are going to get sued
> like hell or people will stop buying/flying their planes if they
> crash.
>
> That goes for anything and everything thats made........The regulations
> itself is a HUGE inefficiency and is not needed. Just MO.

May 15 02:57 PM

[Andy1234:]

I work in the aerospace industry....While we do try to maximize profits....I highily doubt that the excessive stranglehold of regulations really does much. In fact.....it is very counterproductive and adds a large amount of cost to our operations.




On May 15 02:57 PM wpdragon wrote:

> Too many companies think it is in their best interest to make as
> much money as they possibly can, and they are more than willing to
> cut corners wherever they think they can get away with it in that
> pursuit. And they hire plenty of lawyers and marketing/PR staff to
> deny any wrongdoing in that regard. People die that way, or are grievously
> injured.
>
> That is why you regulate companies and industries, because if you
> are too naive to understand that companies are out for one thing,
> and that is too make monstrous profits while they deny liability,
> then you are likely to be the one injured at some point.

May 15 04:08 PM

[ain't no fo...:]

Andy, it may be that your industry is different because of its high public profile - I don't know. I am going to CC: a comment here from another SA blog entitled "Barney Frank Wants to Regulate Your Pay" (A title I find highly ludicrous by the way). Anyway, the guy who commented is much more eloquent than I in getting his point across:

Xyrus86 CommentsFollow
If humans were moral creatures by nature, then reforms like the ones Frank seems to favor would be laughable (and indeed unnecessary).

However, as humans have demonstrated time and time again, we are not moral creatures. When large amounts of money and/or power come into play, it's amazing how far people will twist their moral compass in order to justify their actions.

While perhaps the policies themselves may not be the best thought out, they are trying to address a fundamental problem: How do you stop companies and the people who run them from being...well...a$$holes.

If you get compensated for the number of sales you bring in, you're going to do anything you can to increase sales. Similarly, if you get compensated for the performance of stock price, you're going to do what it takes to get the stock price up.

The problems start when morality gets pushed into a distant second relative to profits. That's when things like sweatshops and poisoning third world shanty towns with toxic waste and destroying the world financial system start showing up.

A free market is amoral. It does not work for the greater good, nor does it work for the greater evil. It works for profits, and anything that doesn't affect the bottom line negatively is fair game. If running your own third world nation of slaves improves that bottom line and keeps the customers and investors lining up, then so much the better.

So how do you keep the markets (and people in general) moral? By removing regulations? Hardly. By adding more? Slippery slope. It has been, and always will be, a careful balancing act.

~X~




On May 15 04:08 PM Andy1234 wrote:

> I work in the aerospace industry....While we do try to maximize profits....I
> highily doubt that the excessive stranglehold of regulations really
> does much. In fact.....it is very counterproductive and adds a large
> amount of cost to our operations.
>
>

May 16 09:47 AM