Post by Sapphire Capital on Sept 5, 2008 21:40:45 GMT 4
Source: Daisy Ku
INTERLAKEN, Switzerland, Sept 5 (Reuters) - Over-the-counter (OTC) trades in credit derivatives are increasingly likely to be cleared centrally as regulators look to rein in risk, opening the lucrative market to competition from exchanges.
Banks and other financial firms have lost over $400 billion on credit-related writedowns in the last year, and a central counterparty could have helped risk awareness.
"More OTC market trades will be cleared through a central clearing house in the next 12 to 18 months, given the regulatory concerns," said Mark Yallop, chief operating officer at ICAP (IAP.L), the world's largest broker between banks.
Growth in OTC derivatives has easily outpaced a rise in exchange-traded derivatives contracts in the last two years, thanks to the greater flexibility and innovation of the off-exchange segment, which can offer tailor-made instruments.
But, from a regulatory perspective, the downside for OTC trades is that basic trade details, such as the notional amount of credit default swaps (CDS) trades, are not affirmed between counterparties on the trade date, as many of these privately negotiated derivatives trades are conducted manually, by phone.
This has the potential to create backlogs and errors -- a big concern of both market participants and regulators as the financial industry rattles through the credit crisis.
The possible systemic risks posed by the $62 trillion credit derivative OTC market have prompted calls for a central clearing system to help ease concerns about counterparty risk.
With 84 percent of the world's derivatives traded on OTC markets, exchanges are keen to step in
NYSE Liffe, part of NYSE Euronext (NYX.N)(NYX.PA), will begin clearing credit default swaps based on the benchmark European credit derivative indexes in the fourth quarter.
Eurex Clearing, the post-trade service unit of Deutsche Boerse (DB1Gn.DE), plans to launch a platform to clear CDS trades in the first half of next year.
"We reduce overall counterparty risk (and) increase transparency and efficiency in the market place. Eurex Clearing is the largest central counterparty in Europe, that gives us the infrastructure to expand into OTC products," said Eurex's Thomas Book at the Swiss Futures and Options Association annual meeting.
Also, this week, CME Group (CME.O), the world's biggest derivatives exchange, extends its clearing for OTC interest rate swaps.
But, investment banks are reluctant to see their OTC business move to exchanges.
"There is an inherent resistance from the upstairs community to have credit derivatives products traded on exchanges," said Chicago Board Options Exchange Chairman and CEO William Brodsky.
As OTC products mature, the terms of trade become increasingly standardised. With such commoditisation, OTC products can move away from bilateral voice broking towards the multilateral electronic broking, and hence become reminiscent of a conventional exchange.
CBOE plans to launch credit default options in the fourth quarter to lure trades from OTC markets.
"Because of what happens in the major institutions, there is a reluctance to deal in OTC derivatives because of the counterparty risk, therefore we're trying to create exchange-traded products that provide the same type of protection," said Brodsky.
INTERLAKEN, Switzerland, Sept 5 (Reuters) - Over-the-counter (OTC) trades in credit derivatives are increasingly likely to be cleared centrally as regulators look to rein in risk, opening the lucrative market to competition from exchanges.
Banks and other financial firms have lost over $400 billion on credit-related writedowns in the last year, and a central counterparty could have helped risk awareness.
"More OTC market trades will be cleared through a central clearing house in the next 12 to 18 months, given the regulatory concerns," said Mark Yallop, chief operating officer at ICAP (IAP.L), the world's largest broker between banks.
Growth in OTC derivatives has easily outpaced a rise in exchange-traded derivatives contracts in the last two years, thanks to the greater flexibility and innovation of the off-exchange segment, which can offer tailor-made instruments.
But, from a regulatory perspective, the downside for OTC trades is that basic trade details, such as the notional amount of credit default swaps (CDS) trades, are not affirmed between counterparties on the trade date, as many of these privately negotiated derivatives trades are conducted manually, by phone.
This has the potential to create backlogs and errors -- a big concern of both market participants and regulators as the financial industry rattles through the credit crisis.
The possible systemic risks posed by the $62 trillion credit derivative OTC market have prompted calls for a central clearing system to help ease concerns about counterparty risk.
With 84 percent of the world's derivatives traded on OTC markets, exchanges are keen to step in
NYSE Liffe, part of NYSE Euronext (NYX.N)(NYX.PA), will begin clearing credit default swaps based on the benchmark European credit derivative indexes in the fourth quarter.
Eurex Clearing, the post-trade service unit of Deutsche Boerse (DB1Gn.DE), plans to launch a platform to clear CDS trades in the first half of next year.
"We reduce overall counterparty risk (and) increase transparency and efficiency in the market place. Eurex Clearing is the largest central counterparty in Europe, that gives us the infrastructure to expand into OTC products," said Eurex's Thomas Book at the Swiss Futures and Options Association annual meeting.
Also, this week, CME Group (CME.O), the world's biggest derivatives exchange, extends its clearing for OTC interest rate swaps.
But, investment banks are reluctant to see their OTC business move to exchanges.
"There is an inherent resistance from the upstairs community to have credit derivatives products traded on exchanges," said Chicago Board Options Exchange Chairman and CEO William Brodsky.
As OTC products mature, the terms of trade become increasingly standardised. With such commoditisation, OTC products can move away from bilateral voice broking towards the multilateral electronic broking, and hence become reminiscent of a conventional exchange.
CBOE plans to launch credit default options in the fourth quarter to lure trades from OTC markets.
"Because of what happens in the major institutions, there is a reluctance to deal in OTC derivatives because of the counterparty risk, therefore we're trying to create exchange-traded products that provide the same type of protection," said Brodsky.