Summit News

Wary investors push derivatives to exchanges

NEW YORK (Reuters) - Banks have generated billions of dollars of profits from standing in the middle of trades in the $530 trillion over-the-counter derivatives market, but investors could clamor to do more of their trading in coming years with exchanges, which are seen as safer.

Investors are wary of over-the-counter derivatives, privately negotiated contracts that have proved to be only as stable as the institutions that sold them, speakers at the Reuters Global Finance Summit said.

The idea of regulating the over-the-counter market, and creating central exchanges or clearinghouses to help manage trading, is already gaining currency in some markets.

U.S. securities regulators are discussing creating a central counterparty for credit-default swaps, which are derivatives that insure against bond and loan defaults.

Regulators and exchange companies in the past have tried to trade these contracts on exchange, but their efforts stalled in part because banks were reluctant to step away from over-the-counter markets, and the fat trading revenue they offer.

But investors and regulators may now have the upper hand.

“The credit default swap market certainly ... appears to now warrant some sort of regulation,” said Anton Schutz, president and chief investment officer of Mendon Capital Advisors Corp, in Rochester, New York.

In addition, bank shareholders are increasingly skeptical about banks holding securities that are not transparent and are difficult to value.

“Isn’t it ironic that the securities that caused the most disarray for the sell side firms are the ones that they wanted to sell to me that they had to keep on their books?” asked Robert Kapito, president of asset management firm BlackRock, which trades and invests in derivatives.


Banks are shifting toward offering standardized and simple products in response to changing investor demand.

“Plain or plain-ish vanilla products, they will come back,” said Meredith Whitney, analyst at Oppenheimer & Co.

Investors will return first to “the large and most liquid derivatives markets that people have the most confidence in,” said Kapito.

"The derivatives markets ... still don't have the appropriate infrastructure for the volume and the diversity of securities that they have," he added.

And a return to simple, standardized products may be a good thing.

“I no longer, as an investor, like the idea that (banks) have thousands of specific contracts that I can’t get a handle on,” said Gary Parr, deputy chairman of Lazard. “I would like to know that there’s some form of standardization,” he added.

But if history is any guide, after the return to simplicity, complex products will ultimately come back, Whitney said.

“When demand for yield comes back ... the financial markets will meet the demand,” she said.

Reporting by Elinor Comlay; editing by Richard Chang