Not surprisingly, the five major banks that control roughly 97% of the OTC derivatives business worldwide have been fighting OTC clearing tooth and nail in Europe, just as they have in the United States, where the Dodd-Frank Wall Street Reform and Consumer Protection Act aims at a similar migration.
Baum believes the potential windfall for exchanges — and for small prop-shops looking to trade OTC derivatives products — has been understated.
"You usually hear that standardized products will go to clearing, while non-standardized products will remain OTC," he says. "The next question is: What is standardized?"
As a product developer at Eurex, he worked with EU regulators to determine what was and wasn’t standardized, and he concluded that 90% of all OTC products are simple enough to be cleared centrally.
"If you look at the statistics, the vast majority of swaps are interest-rate swaps, and the vast majority of those traded — especially after 2008 — are fairly vanilla," he says. "The attitude of the banks, naturally, is that these things are not standardized, because they’re defining standardized as having fixed delivery dates — say, six delivery dates each year, like corn has, and which OTC contracts never have because OTC is in the spot market. The banks make a big deal out of it in their lobbying, but it’s a non-issue."
He says he wouldn’t be surprised to see regulators mandate the opening of Eurex Clearing as a condition for approving the merger.
Even if the regulators don’t force OTC derivatives onto clearinghouses, the high capital requirements currently in the works may do the job — but both scenarios may have unintended consequences, warns Belchambers.
"In the current environment, the prudential rules around clearinghouses are likely to be very much driven by safety-first principles, meaning you’ll have capital rules, default funds — anything to make them as near bomb-proof as possible," he says. "That’s all great in theory, but the trouble is that somebody will have to pay for that, and the result may be that risk management is no longer a viable economic activity — OTC or otherwise — generating an outcome that is less about risk mitigation and more about risk transfer from the derivative to the underlying"
"In an effort to make clearinghouses bomb-proof, you could reintroduce the kind of underlying risk that derivatives were invented to reduce," he says.