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After scandals, Chicago says best derivatives model is theirs

CHICAGO, Nov 1 (Reuters) - The big-bank dominated model for privately traded derivatives is broken and those in the futures business argue that the fix is in Chicago.

Banks are grappling to adapt to a wave of new regulations designed to rein in their trading activities and reduce risks associated with the $648 trillion privately traded derivatives markets that they dominate, which were a key contributor to the 2007-2009 financial crisis.

Recent scandals, including revelations that banks sought to manipulate the widely referenced London interbank offered rate (Libor) to benefit large derivatives trading positions based on the benchmark have even further eroded the trust of many investors in the banks, even under new regulations.

``There is no trust in the current sell-side orientated approach,'' Clifford Lewis, an executive vice president at State Street Global Markets, said at a futures industry conference.

The Libor revelations show that the banks have ``victimized'' buy-side firms. ``This is a transformational event.'' Going forward, ``I think the solution is going to be found in Chicago and the Chicago community. Not by Wall Street or (London's) Lombard Street,'' he said.

The word increasingly adopted for the transformation of the privately traded swaps markets is that they are being ``futurized,'' or made to more closely resemble the futures contracts so prevalent in Chicago.

This is not by accident. The approach of the chief U.S. derivatives regulator, the Commodity Futures Trading Commission (CFTC), in many of its new rules for the industry is to make the contracts more similar to exchange-traded contracts.

Key tenets of reform are: central clearing, electronic trading and price transparency.

CFTC Chairman Gary Gensler said on Thursday that Dodd-Frank reforms, passed in 2010 to regulate privately traded derivatives, borrowed from ``what has worked best in the futures markets...

''The role of finance is to serve the rest of the economy. The futures market has done so for decades by providing price discovery and liquidity through transparent and competitive markets.`` he said.

Chicago Mayor, and former White House Chief of Staff, Rahm Emanuel, who told Gensler he got the chairman's job, said the futures markets maintained order when others were inefficient and ineffective during the financial crisis.

''The one place that did very well was the futures market,`` he told conference attendees.

Higher margins required to back over-the-counter derivatives are already helping to push more business to futures.

Bill Brodsky, Chairman and Chief Executive Officer of the Chicago Board Options Exchange, said that the exchange has already seen a pick up in volumes from investors shifting from over-the-counter products.

The exchange is actively marketing its contracts, many of which can be customized, to companies including insurers and pension funds as alternatives to over-the-counter swaps, he said.

CME Group is also seeing an uptick in interest from customers seeking to transition to futures from swaps, though ''right now they tend to be the smaller players,`` said Kim Taylor, president of CME Clearing.

Meanwhile, a number of battles continue about over-the-counter derivatives reform, where many firms seeking to increase market activity say that the big banks are slowing and stymieing change in order to protect the lucrative revenues from the opaque markets.

This has been a delicate topic for some, as many bank representatives from New York have been unable to travel to Chicago to share their view this year because of weather-related transport shutdowns.

CFTC Commissioner Scott O'Malia declined to debate a contentious issue relating to rules over how quickly trades must be accepted by central clearinghouses at the Commission's technology meeting in Chicago on Tuesday, citing the absence of bank attendees.