New U.S. derivatives rules could make odd partners

NEW YORK (Reuters) - New U.S. rules for the trading of derivatives could drive market enemies into each other’s arms, as dealers and exchanges look to strike more partnerships to yield shared profits from the revamped landscape.

Traders work on the floor of the New York Stock Exchange May 19, 2009. REUTERS/Shannon Stapleton

The Obama administration’s proposals, announced last week, favor exchange and clearinghouse operators because they require “standardized trades” to move onto exchanges, and require all over-the-counter derivatives to be cleared by regulated central counterparties.

That would effectively transfer a very lucrative business from derivatives dealers, blamed by many for the financial crisis, to exchanges and clearinghouses, which have touted their durability since markets plunged last year.

They have long waged a tug-a-war for control over where derivatives trade, with the dealers’ private OTC market mostly dominant. The new regulations may force the dealers and exchanges to work more closely together.

“There were already initiatives underway to have exchanges partner with dealers, and this helps accelerate what was already underway,” Matthew Lavicka, managing director of cash equities at Goldman Sachs & Co, which is among the top U.S. derivatives dealers, told Reuters on Wednesday.

Goldman and several other big banks own a 50-percent equity stake in IntercontinentalExchange’s clearinghouse for credit default swaps. Dealer backing pushed ICE to the fore of clearinghouses looking to clear U.S. CDS, default-insurance products blamed for worsening the crisis.

The world’s biggest exchanges, including CME Group Inc, NYSE Euronext and Nasdaq OMX, have sought partnerships with dealers and other big OTC players who would drive business to their derivative clearinghouses and exchanges.

“You can’t just build it and have them come,” said Larry Leibowitz, head of U.S. markets and global technology at New York Stock Exchange parent NYSE Euronext. “We’ve been launched in Europe for a while and people aren’t really using it,” he said of the company’s five month-old European CDS clearer.


Broker-dealers earn money from trading or facilitating the trade of derivatives, instruments that derive their value from other assets. Because the $194 trillion U.S. OTC market eclipses the $7 trillion exchange-traded market, exchanges have salivated at the prospect of grabbing a bigger slice.

But they have had little success because derivatives are tailored specifically for those who trade them, and exchanges typically trade standardized products for wider consumption.

The Obama administration’s plans, meant to avoid a repeat of the financial meltdown that sparked a global recession, could change the equation.

“A lot of what was signaled there was that the administration was trying to get the regulators, the sellside, the buyside and the exchanges all to work together,” said Rick Redding, CME Group’s managing director of products and services.

“I think directionally, it was telling the market participants they need to work in a more collaborative way to come up with solutions,” he said on Wednesday in an interview on the sidelines of a conference hosted by Fox-Pitt Kelton here.

An OTC derivatives trade is a private agreement between two parties. Regulators want to install a clearinghouse between those trades to act as a central counterparty that would guarantee the obligations if any participant defaults.

Chicago-based CME, the world’s top derivatives exchange, is delaying the launch of its CDS exchange and clearinghouse until it has more stakeholders signed on. CME is already partnered with hedge fund giant Citadel in the venture, seen as a rival to ICE’s clearinghouse, which launched in March.

Scott Hill, ICE’s chief financial officer, told the conference: “One of the ways to demonstrate yourself as a trusted partner is to come up with mutually beneficial solutions, and we think we’ve done that.”

Nasdaq OMX is looking for partners in its clearinghouse for the larger OTC interest rate swap market. CME and London-based clearinghouse LCH.Clearnet also clear interest rate swaps, contracts that allow for the exchange of future interest payment obligations.

Cross-town rival NYSE Euronext, meanwhile, said last month it had signed a non-binding agreement for “several leading market participants” to take an equity interest in its U.S. derivatives-trading platform.

The flurry of handshakes represents something of a return to the previous decade, when dealers owned major stakes in exchanges, which had not yet gone public.

“Our interests became even less aligned when we went public and demutualized,” from the dealers, NYSE’s Leibowitz said on the sidelines of the conference. “Now this is a way to get us back on the same page.”

Reporting by Jonathan Spicer; editing by Carol Bishopric