CHICAGO Nov 1 The big-bank dominated model for
privately traded derivatives is broken and those in the futures
business argue that the fix is in Chicago.
Banks are grappling to adapt to a wave of new regulations
designed to rein in their trading activities and reduce risks
associated with the $648 trillion privately traded derivatives
markets that they dominate, which were a key contributor to the
2007-2009 financial crisis.
Recent scandals, including revelations that banks sought to
manipulate the widely referenced London interbank offered rate
(Libor) to benefit large derivatives trading positions based on
the benchmark have even further eroded the trust of many
investors in the banks, even under new regulations.
"There is no trust in the current sell-side orientated
approach," Clifford Lewis, an executive vice president at State
Street Global Markets, said at a futures industry conference.
The Libor revelations show that the banks have "victimized"
buy-side firms. "This is a transformational event." Going
forward, "I think the solution is going to be found in Chicago
and the Chicago community. Not by Wall Street or (London's)
Lombard Street," he said.
The word increasingly adopted for the transformation of the
privately traded swaps markets is that they are being
"futurized," or made to more closely resemble the futures
contracts so prevalent in Chicago.
This is not by accident. The approach of the chief U.S.
derivatives regulator, the Commodity Futures Trading Commission
(CFTC), in many of its new rules for the industry is to make the
contracts more similar to exchange-traded contracts.
Key tenets of reform are: central clearing, electronic
trading and price transparency.
CFTC Chairman Gary Gensler said on Thursday that Dodd-Frank
reforms, passed in 2010 to regulate privately traded
derivatives, borrowed from "what has worked best in the futures
"The role of finance is to serve the rest of the economy.
The futures market has done so for decades by providing price
discovery and liquidity through transparent and competitive
markets." he said.
Chicago Mayor, and former White House Chief of Staff, Rahm
Emanuel, who told Gensler he got the chairman's job, said the
futures markets maintained order when others were inefficient
and ineffective during the financial crisis.
"The one place that did very well was the futures market,"
he told conference attendees.
Higher margins required to back over-the-counter derivatives
are already helping to push more business to futures.
Bill Brodsky, Chairman and Chief Executive Officer of the
Chicago Board Options Exchange, said that the exchange
has already seen a pick up in volumes from investors shifting
from over-the-counter products.
The exchange is actively marketing its contracts, many of
which can be customized, to companies including insurers and
pension funds as alternatives to over-the-counter swaps, he
CME Group is also seeing an uptick in interest from
customers seeking to transition to futures from swaps, though
"right now they tend to be the smaller players," said Kim
Taylor, president of CME Clearing.
Meanwhile, a number of battles continue about
over-the-counter derivatives reform, where many firms seeking to
increase market activity say that the big banks are slowing and
stymieing change in order to protect the lucrative revenues from
the opaque markets.
This has been a delicate topic for some, as many bank
representatives from New York have been unable to travel to
Chicago to share their view this year because of weather-related
CFTC Commissioner Scott O'Malia declined to debate a
contentious issue relating to rules over how quickly trades must
be accepted by central clearinghouses at the Commission's
technology meeting in Chicago on Tuesday, citing the absence of