London Won't Cash in on Wall Street's Missing Options

Bankers in London hoping for a boom in business if strict financial reform legislation is passed on Wall Street will be disappointed as a migration of funds across the pond will likely fail to materialize.


British regulators will most likely follow in America’s footsteps on over-the-counter derivatives legislation if the Senate’s Financial Reform Bill passes, according to experts.

“I think the world is waiting for the US’ leadership on this, and that every country will follow suit with what the States is doing,” said Michael Greenberger, professor at the University of Maryland Law School, and a former official at the Commodities and Futures Trading Commission.

The trend may also echo beyond London and into Europe, Greenberger said.

“The EU and Euro Commission are ready to take a harsh stance on speculative trading,” he said. “They’re very upset with what’s happened with Greece, Spain, and Portugal.

France and Germany especially are looking for ways to restrain trading of OTCs.” The reform bill could severely limit the over-the-counter derivatives market, which is primarily made up of swaps.

JPMorgan Chase and Goldman Sachs are the biggest players in the swap market, and just five banks account for nearly 97 percent of the over $200 trillion worth of derivatives held by U.S. commercial banks, Reuters reported.

Exodus Unlikely

Many market watchers have argued that banks will simply move operations to other countries if regulations on swaps becomes too onerous.

Dennis Davitt, head of equity derivatives at Macquerie Bank, said that premise is plausible.

The reform bill “is not going to attract people to New York,” he said. “You may see derivatives business flourish in Singapore, and other stable Asian economies.”

Others argue that the OTC market won’t move overseas, but the banks’ derivatives business will be taken up by numerous smaller derivatives brokers -- true to the nature of a reform bill that aims at preventing “Too Big to Fail.”

“Of the bankers who say ‘well, we’ll just move the business,’ the vast majority will just move their electronic business, but not physical,” Greenberger said.

“You see this in all regulatory reforms – environmental, etc. People don’t just ditch their lives like that. They have houses in the Hamptons.”

Managing Risk

Derivatives have come under fire for their role in the financial crisis for their risky nature and lack of transparency.

But the contracts aren’t just used in Wall Street. Many of the world's biggest companies are exposed to these contracts, buying or trading swaps to control their interest rate, foreign exchange or commodity risks.

Some experts argue that without banks to provide liquidity to this vast market, the cost of buying those swaps would rise significantly.

But others, like Greenberger disagree .

“The problem with most of these contracts is that are both parties are speculating,” he said.

“They’re not being used to support genuine commercial activity.” "If the reform bill passes, banks could move away from swaps and equity and index derivatives will become the framework for over-the-counter derivatives," Scott Fullman, derivatives strategist at WJB Capital, said.

Mom-and-Pop Swaps?

But how realistic is it for regulators to try and tame the multi-trillion dollar OTC industry on a global scale? “I think there’s always going to be an over-the-counter market,” Fullman said.

“There’s always going to be a need for products that aren’t standardized.

The ability to get bespoke OTC contracts listed on the exchange is very hard. If it was easy, they would have already done it,” Davitt added.

“If you make all derivatives exchange-traded, what will really change? Are regulators worried about transparency or too big to fail? Making derivatives more transparent will only compress bid-ask spreads.

But it won’t fix ‘Too Big to Fail.’” And exchange-traded derivatives opens up the market to retail investors.

“If most derivatives become traded on an exchange, anyone can point and click,” Davitt said.

“That includes mom and pop.”