by Jon Brownridge

Created on: May 15, 2009   Last Updated: May 22, 2009

Companies Benefiting From Regulation of the Derivative Market

One of the most obvious contributing factors to the current global financial crisis has been the long-standing and chronic lack of regulation in almost all sectors of the financial world.. This has been well documented in a number of prestigious publications, but most notably by Gillian Tett in her recently-published book, Fool's Gold. In her account of the financial meltdown, Tett identifies the introduction of unregulated 'credit derivatives', the brainchild of a J.P.Morgan think tank in 1994, as the originator of the crisis. The Obama administration. obviously agrees that the derivative market is a potential source of further trouble. It is now committed to the implementation of a more stringent regulatory oversight of the financial system, and in particular, it has moved to exert more control over derivative trading.

The announcements made on May 13, 2009 by Treasury Secretary Timothy Geithner refer specifically to over-the-counter (OTC) transactions, which is understandable as this kind of trade is very difficult to monitor and supervise. The government has indicated that it will implement a 'robust regime of prudential supervision and regulation' over OTC transactions that will significantly affect both reporting and margin requirements, and for the first time, all OTC derivative products must be centrally cleared.

Although the new regime of supervision may cramp the style of some traders, clearinghouse companies stand to benefit from the new regulations. Clearinghouses bring stability and openness to the markets, and since government regulators have urged the creation of more clearinghouses to deal with the instability of credit derivatives, valued in trillions of dollars, there has been no shortage of large companies wishing to be involved. In fact there has been some significant jockeying for position recently by companies wanting the business of clearing OTC derivatives.

One of the main contenders for this new business is the Intercontinental Exchange (NYSE: ICE) which already has significant OTC experience. Many large dealers own a stake in ICE, and this has benefited the company by providing it with strong support from well established and well-known financial institutions. International Exchange began clearing credit default exchanges in March of this year.

Another major contender for OTC clearing is the CME Group Inc. (NASDAQ: CME). This company runs the Chicago Mercantile Exchange and like ICE it is well experienced in clearinghouse business. On May 8, 2009, CME announced the launch of clearinghouse services for OTC derivative trading making the company the largest trader of derivatives in any exchange.

The involvement of companies like ICE and CME in clearing credit derivatives is a positive step towards market stability. Over-the-counter dealers of these products have been unregulated for far too long; it was traders like Bank of America, JPMorgan Chase, Merrill Lynch, Citigroup, and others, who created the massive backlog of trades that required the implementation of new regulations. Not surprisingly, ICE and CME have already benefited from their participation in clearing OTC derivatives. The shares of both companies rose this week as news of their involvement leaked into the markets, indicating a new confidence in their ability to provide new stability and openness.

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