The Banks Aren’t Ready to Give In on Derivatives Yet

A week or so ago it looked like everyone was on board with the plan to put most derivatives into a central clearinghouse and allow certain bespoke contracts to be traded outside of it but with disclosure. Well, guess what? The big banks are working behind the scenes to alter things. You didn’t think it was going to be this easy did you?

From the WSJ:

A group of banks and money managers will next week present a plan designed to help fend off some rules proposed by the Obama administration, which is seeking to control trading in the opaque market for over-the-counter derivatives.

Earlier this month, the U.S. proposed giving the Securities and Exchange Commission and the Commodity Futures Trading Commission authority to mandate centralized clearing of certain derivatives, impose new trade-reporting requirements, and force trading of “standardized” contracts onto exchanges or electronic platforms that will make prices more transparent.

Wall Street banks with large derivative-trading businesses have been outwardly supportive of greater regulatory oversight of the $684 trillion market. But behind the scenes, there has been hand-wringing over the details of certain proposals and discussions about how the industry can help shape the rules.

Potentially billions of dollars in revenue is at stake. An effort earlier this decade to improve transparency in the corporate-bond market ended up cutting bank fees by more than $1 billion in a year, according to some studies.

In the letter, expected to be released next week, the banks will reiterate a commitment to meet the government’s goal of transparency.

The industry will detail plans to expand central clearing of credit-default swaps to investment funds and other market participants. It also will propose that customized credit derivatives like those that nearly brought down American International Group Inc. be reported to a trade-information warehouse run by Depository Trust & Clearing Corp. On Thursday, DTCC moved to have its warehouse overseen by the Federal Reserve as it seeks to align itself with regulators’ goals.I

So far, some regulators and politicians are holding a hard line, insisting that radical changes are needed to avoid a repeat of last year’s market panic when large financial firms neared collapse and no one knew how linked they were to others through derivatives. The reforms also mean that “the days of conducting standardized derivative trades over the phone will soon be over,” said one senior administration official.

It’s too soon to get all lathered up about this. Plenty of time for that once we see the proposal but forewarned is forearmed. I suspect that little good will come of all of this.

I’ll reiterate my position. I do not think that anyone understands these instruments well enough to have them exist in any form other than one that transmits the maximum amount of information to the regulators and public. Clearly, this is a narrow market with risk highly concentrated in a few financial institutions. With experience and more understanding it might be entirely possible to allow them to be created and traded both on and off an exchange. The preferred method of arriving at that point should be one that entails working backwards from full regulation.

About Tom Lindmark 401 Articles

I’m not sure that credentials mean much when it comes to writing about things but people seem to want to see them, so briefly here are mine. I have an undergraduate degree in economics from an undistinguished Midwestern university and masters in international business from an equally undistinguished Southwestern University. I spent a number of years working for large banks lending to lots of different industries. For the past few years, I’ve been engaged in real estate finance – primarily for commercial projects. Like a lot of other finance guys, I’m looking for a job at this point in time.

Given all of that, I suggest that you take what I write with the appropriate grain of salt. I try and figure out what’s behind the news but suspect that I’m often delusional. Nevertheless, I keep throwing things out there and occasionally it sticks. I do read the comments that readers leave and to the extent I can reply to them. I also reply to all emails so feel free to contact me if you want to discuss something at more length. Oh, I also have a very thick skin, so if you disagree feel free to say so.

Enjoy what I write and let me know when I’m off base – I probably won’t agree with you but don’t be shy.

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