In all the excitement over derivatives, reformers have made clear that these products need to be traded on exchanges and centrally cleared to create both transparency and accountability -- no more hidden risk, and clearinghouses will have to take responsibility for defaults and force companies to put up their capital in advance. But the exchanges themselves are none too happy about being forced to deal with some of the crazy derivatives out there:
Big exchanges and clearinghouses are key planks in the U.S. government's plan to revamp derivatives markets, but the fierce competitors warned in near-unison on Tuesday that lawmakers should not recklessly force more products through them than is appropriate.
Exchange operators have raced to launch clearinghouses ahead of any new laws, often signing on big dealers as revenue-sharing members in order to attract trading. They have warned in the past that not all OTC products are suitable for clearing, and that even fewer are suitable for exchange-trading.
"The two issues that were at the core of the financial crisis were lack of transparency and lack of central clearing," Thomas Callahan, head of NYSE Euronext's U.S. futures business, told the conference. "What you're seeing is all sorts of people with various agendas coming in and piling on these issues, and certainly some of these issues could be horrifically disruptive to our business."
Now, a lot of that article is empty hand-waving, and many exchanges want to maintain their financial relationships with large banks, so there is an element of political influence there that must be separated from their analysis of the problem. Nonetheless, it is interesting that some of these products are appear to be so risky that they cannot be traded in regularized marketplace with clear rules, or rather, the clearinghouses -- which would be responsible, along with their investors, for the costs in the event of the default -- don't want to cough up the cash if these deals go sour. Maybe now the bankers know how taxpayers felt last year.
You can envision a couple of scenarios if lawmakers ignore these objections and put strict requirements for clearing and exchange trading in the bill,as they should. Forcing the financial sector to take responsibility for the costs of risky derivatives might make them leery about using them. It will certainly dampen profits for the five big firms -- Goldman, JP Morgan et al. -- who make up the bulk of the derivatives trade. If you believe the firms warnings, it could end with risk getting seriously out of control at the exchanges and potential failure. When you cry wolf about everything, though, it's hard to be taken seriously. I'd rather see failure come through a clearing and exchange system rather than accept the inevitability of a much broader derivatives disaster by letting these products remain unsupervised.
-- Tim Fernholz
