Last week’s The Economist has a write-up on the new regulations that will eventually control the several trillions of dollars of notional amounts underlying the OTC derivatives that are currently being traded. Firstly, it seems that the political theatre that was the Goldman scandal had some effect:
The fraud charges filed against Goldman Sachs, over synthetic derivatives, emboldened those looking to crack down on exotic instruments. On April 21st the Senate’s Agriculture Committee—which oversees the Commodity Futures Trading Commission (CFTC)—passed a surprisingly draconian set of derivatives provisions. Elements of this will be offered as an amendment to the main bill. [link]
The main part of the bill on the table is Section 106 which will deny access to the Fed’s discount window to those banks that trade swaps. The Fed’s discount window, as some of you may know, is that part of the central bank that lends directly to banks. The discount rate (the lending rate from the discount window) is usually about 100 basis points above the Fed Funds rate, which is the bank-to-bank lending rate. When banks can’t find other banks to provide them with some cash, they go to the Fed. In times of crisis, the discount window proves to be quite useful, and that is why, over the last two years or so, the Fed decreased the spread between the discount rate and the Fed Funds rate to 50 basis points, and extended the lending period from overnight to 30 days, and then to 90 days.
Whether the section is a bargaining chip or not, denying access to the discount window, the article states, will send banks scurrying off to spawn non-bank subsidiaries that do trade swaps, so not sure if that will change anything apart from inconvenience them. However, the parties most hurt by this are those who actually use the derivatives for hedging risk, e.g., airlines to hedge against rises in jet fuel prices, also known as “end-users”:
Many of those end-users, which collectively hold 10-15% of OTC derivatives outstanding, also want exemptions from clearing. Without one, they argue, increased collateral requirements for cleared trades would make hedging their everyday risks much more expensive. As things stand, some commercial firms would get an exemption, while others—such as sweetmakers hedging against swings in sugar prices—would not. [link]
We shall see how this unfolds. Meanwhile, entrepreneurs looking to cash in on the new regulations – here’s your next business idea: Start a derivatives exchange.