Traders and regulators obviously disagree about how the new regulation of the OTC derivative market will affect the entire market.The regulators point to the financial crisis and the heavy use of derivatives, which on their own are not an asset and do not hold value but rather derive their value from a product of value, that led to it.
The traders make the point that derivatives do good: They allow firms like pension funds to hedge risk.
The good and the bad also come hand in hand on the topic of how derivatives affect a company’s bottom line on a day to day basis.
A Morgan Stanley trader told Reuters:
“Dealing with a bank direct on an OTC basis enables a corporation to utilise the bank’s credit line, and thus removes the administrative burden of managing daily margin calls.”
Of course, meeting daily margin calls using derivatives might also leave room for a company to report a bottom line that is more favourable than it really is. On the other hand, it might also paint a more accurate picture of how a company is really doing and prevent a company from looking like it’s in terrible shape when it really isn’t.
But where the argument gets a little ridiculous is when bankers reveal that they’re worried that the new regulation will hurt their pocket books.
“Players in the market understand the regulatory burden will increase, profits in the industry will shrink,” says a new Reuters special report on regulation of the OTC derivatives market.
Their problem with the regulation stems from the fact that there’s a big ideological question up for debate right now.
From the report:
Some bankers even see the new regulations as one weapon in an ideological war against them. Should the entitlement to enter into private trading now be seen as exceptional rather than the norm, they ask.
And the fact that regulators say they don’t want to regulate the part of the derivatives market that helps company’s like airlines hedge against the cost of rising cost of fuel.
From the report:
“We’re aware and focused on the cost of a six-pack because we also oversee agricultural markets,” Commodity Futures Trading Commission Chairman Gary Gensler told Congress this month after Reiners’ remark. “I would say our intention is not to have margin requirements applied to an end user such as MillerCoors,” said Gensler.
The debate: is the government entitled to regulate private markets?
Because regulators like Gensler say they only want to regulate traders, they feel like they’re getting attacked.
Of course, we don’t want the government regulating all private markets, otherwise, a lemonade stand could get regulated. But that’s getting a little ahead of ourselves. The OTC market is a $600 trillion industry.
The new regulation proposes regulating just a portion of the ~$50 trillion OTC derivatives market.
From Title VII of the bill:
The bill would impose several requirements on public and private entities such as pension funds, swap dealers, and other participants in derivatives markets. For example, the bill would place new requirements on derivatives; require reporting by entities that gather trading information about swaps, organisations that clear derivatives, facilities that execute swaps, pension funds, and swap dealers; and establish capital requirements for pension funds, swap dealers and major swap participants.
And even though it sounds like the regulations are far-reaching, some argue that traders will just find new ways to game the regulations. Click here to read how the new regulations are somewhat futile >