Financial overhaul likely to benefit clearinghouses

By Robert O'Harrow Jr.
Washington Post Staff Writer
Wednesday, May 5, 2010; A17

The effort to overhaul financial regulation, aimed in part at improving oversight of complex derivatives transactions by making them more transparent, could be a boon for some of the world's largest financial clearinghouses and exchange operations.

Because the legislation is still being crafted in the Senate, it is too soon to identify the biggest beneficiaries. Much also will depend on how the new market for derivatives trading and clearing evolves.

But industry analysts said the winners are likely to include the Chicago Mercantile Exchange (CME), an operation in President Obama's home town that already leads futures exchange, and Atlanta-based IntercontinentalExchange (ICE), a futures exchange that has become the most successful clearinghouse of credit-default swaps.

Another beneficiary could be London-based LCH.Clearnet, a world leader in the clearing of one of the most common derivatives, interest-rate swaps.

"The established clearing operations, such as CME and ICE, are seen as the natural beneficiaries," said Dan Fannon, managing director at Jeffries & Co., an investment-banking firm.

The overhaul efforts are aimed at creating control over the vast and often unregulated market for derivatives -- the uncounted private contracts that came to be worth about $600 trillion before playing a crucial role in accelerating the global financial meltdown.

Derivatives contracts are often used throughout the financial world as a risk-management, or hedging, tool. They involve an agreement between two parties that depends on something occurring in the future, such as the performance of an underlying asset such as a commodity, an equity or a bond.

Since the late 1990s, they also have been used by speculators as a form of betting.

As some derivatives became more complex, and more entwined with exotic securities, the risks they posed became essentially unknowable.

The legislation, known as the Wall Street Transparency and Accountability Act, seeks to lessen the risks by restructuring how major banking companies trade derivatives, and by requiring that nearly all derivative contracts be cleared by clearinghouses.

In addition, the legislation contemplates having derivatives traded through exchanges or what the law describes as "swap execution facilities."

Those transactions would be recorded, enabling customers to better monitor past transactions, while helping to promote competition among those buying and selling derivatives.

Patrick O'Shaughnessy, an analyst at Raymond James, said in a briefing paper last week that the mandate to clear what are known as "over-the-counter" derivatives "appears to be a foregone conclusion."

O'Shaughnessy predicted that the CME Group, which runs the Chicago exchange, will see a bump in clearing business for derivatives known as interest-rate swaps and foreign-exchange swaps.

The Chicago Mercantile Exchange has long been a global trading center for futures contracts, a type of exchange-trade derivative. The exchange went public almost a decade ago. Three years ago, it merged with the Chicago Board of Trade.

It also began trying to build its interest-rate and credit-default-swap business, with mixed success, O'Shaugnessy said.

ICE was begun a decade ago by Deutsche Bank, Goldman Sachs, Morgan Stanley Dean Witter and a handful of other firms to facilitate business-to-business derivatives deals involving energy, metals and other commodity-based products.

That means that some investment banks could benefit, at least to some degree, by legislative mandates that drive up business for ICE.

Other winners could include inter-dealer brokers that earn profits by facilitating trades between buyers and sellers of interest-rate swaps and other derivatives contracts.

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