OTC or not OTC?

Obama’s new derivative markets shake-up promised in August to make all OTC derivatives trade on an exchange, presumably in in order to avoid credit risk. However, there seems to be a fair amount of confusion over whether the trades are speculative or simply hedges. In fact, there seems to be a fair amount of confusion. Period. Says, the Economist:

Most of the differences hinge on the definition of a “major swap participant”. No one disputes that big banks should observe tighter rules for derivatives trading, but should oil companies, airlines and fund managers, which routinely use derivatives for hedging, face more regulation too? The stakes are high. In the interest-rate and foreign-exchange markets alone, non-financial firms account for about $50 trillion of derivatives outstanding. Earlier this month over 170 firms, including Ford, Shell and Procter & Gamble, wrote a letter to lawmakers bemoaning the “extraordinary burden” they would face if they had to join clearing houses or allocate their precious cash reserves to margin payments. [link]

Now they’re holding off, and delegating it to the SEC and the CFTC (Commodity Futures Trading Commission), since nobody is sure what to do. Ferreri does make a salient point, though.

The Treasury believes banks dislike exchange-trading platforms because they narrow bid-ask spreads, undermining profitability. Others argue that few OTC derivatives markets are amenable to exchange-trading anyway. “Companies use OTC derivatives like we buy complex holidays from a travel agent,” says Christopher Ferreri of the Wholesale Markets Brokers’ Association, an industry body. “Everyone’s holiday is different and the buyer wants one quoted price.” The Committee on Financial Services removed the exchange-trading requirement (but may backtrack); the Agriculture Committee diluted the definition of an exchange. [link]

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