| NEW YORK, March 25
NEW YORK, March 25 U.S. senators are at an
impasse on details of how to reform the $450 trillion privately
traded derivatives market, and the final bill may determine how
much market share, and profits, large dealers can retain in the
The Senate Banking Committee last week approved a sweeping
bill for financial reform, drafted by Democratic Chairman
Christopher Dodd. For details, see [ID:nN14165412].
The derivatives component of the legislation, however, was
considered a placeholder pending amendments from Senators Jack
Reed and Judd Gregg. Reed, a Democrat, said on Friday that he
and Gregg, a Republican, were unable to agree on details about
exemptions in the bill.
A key question is how many trades are ultimately put into
central clearinghouses, which may then be subject to electronic
trading. This has the potential to narrow trade margins and
shift market share away from dealers to newer players,
Revenues lost from dealers could be significant. Research
and advisory firm TABB Group estimates the top 20 dealers
generate around $40 billion annually from privately traded
derivatives, excluding credit default swaps.
JPMorgan (JPM.N), one of the largest derivatives dealers,
has said it generated a third of its overall investment banking
profits from over-the-counter derivatives between 2006 and
2008, Moody's Investors Service said in a recent report.
The failure of senators to reach agreement, "significantly
diminishes the prospects for OTC derivatives reform becoming
law this year," analysts at Keefe, Bruyette & Woods said in a
The impasse gives dealers time "to take control of the
process themselves and the Europeans to move closer to
regulatory reform before the U.S. revisits next year," they
Central clearing, in which a central counterparty stands
between trading partners and guarantees the trade, is viewed as
key to reducing the risks from derivatives due to the maze of
exposures of the contracts between large institutions that are
considered critical to the financial system.
By removing counterparty risks from the contract, clearing
has the potential to open up trading and brokerage of the
products, allowing investors to bypass large dealers that
currently act as intermediaries to all trades.
The Dodd bill calls for exchange trading of the contracts.
"The bill's requirement that centrally cleared OTC
derivatives be exchange-traded will likely permanently impair
the profitability of this business for dealers," Moody's said.
However, "because the dealers also recognize the threat of
exchange-trading to their profits, the bill's linkage of
central clearing to exchange trading could become an obstacle
to such cooperation," they added. "To protect market-making and
structuring spreads, the dealers could choose to reduce, as
much as possible, the centrally cleared proportion of the
Companies that use derivatives to hedge against interest
rate, currency, commodity and other risks are likely to win
exemptions from clearing because they say that margin
requirements would be too costly.
Defining which companies are hedging, as opposed to
speculating with the contracts, however, may be difficult.
There is also debate over which companies will qualify as
major swap participants and therefore are required to centrally
clear all eligible contracts, and whether this would extend to
large hedge funds or other speculators, in addition to
The Dodd bill defines a major swap participant as someone
whose failure would cause large counterparty losses.
Meanwhile, the Commodity Futures Trading Commission and
Securities and Exchange Commission, which will enforce the
rules, may push for few exemptions.
CFTC Chairman Gary Gensler has said exemptions should be
narrowly applied, and that all financial companies, including
insurance companies and hedge funds, should be required to
centrally clear eligible positions.
Gensler has further said that contracts that are not
cleared should still be traded on electronic trading platforms
to promote transparency and reduce trading costs.
(Reporting by Karen Brettell; Editing by Kenneth Barry)