- Patrick Young
- Exchanges are already muscling into the unruly over-the-counter market
- www.economist.com
Summary
Exchanges are indeed trying to get more access to OTC markets but the markets they can realistically take business in are only likely to be the more commoditised ones…
Analysis
One could view the issue of exchange versus OTC trading in so many different ways. Let’s take two extremes:
Given that OTC trading in money markets consistently dwarfs that of its exchange cousins, it is feasible to argue that exchanges are perhaps the most highly publicised failure in the history of financial markets (aka they retain a very low market share yet onlookers regard them as the rightful market “hub.”
Equally there is the argument that all bilateral trading is a diastrous toxic risk to the economy.
Of course like many extreme statements, there is some truth to both of the above.
However, when it comes to the current market environment, the difficulty in moing markets onto exchange is not quite the same as moving onto CCP and therein lies a significant issue. For instance with CDS et al, the major banks are essentially grudgingly willing (under duress) to move to a CCP model…BUT they aren’t buying into the democratic model of suddenly allowing allcomers access to their wonderful little profit centre (i.e. making markets in the product) and entering a fully open access “democratic” exchange model.
This is a key issue in the whole OTC exchange (or even CCP) transition debate. Banks make a lot of money early(-ish) in the product development cyce in nimble innovative OTC markets. IDBs and banks want to hold onto these cash cows for as long as possible before they become commoditised exchange contracts and the profit margins collapse to nickels and dimes.
Now the exchanges will argue that these nickels and dimes are on the back of vastly inflated volumes and they are generally right insofar as commoditised contracts have progressed. However, the distribution of those many nickels and dimes tend not to go symmetrically back to the folk who made the original OTC market and therefore an impasse is rapidly reached. The OTC market remains highly innovative and open to a relatively limited oligarchy of players.
Without regulatory interaction (i.e. deft pressure or just crude bludgeoning), the exchanges will generally continue to issue open platform CCPs for anything and everything and live in hope that sooner or later banks may just adopt it. As things currently stand, it looks as if a form of CCP apartheid is on track in many markets such as CDS, as the established players do their utmost to secure their cash cow but make the game just transparent enough to allow regulators and politicians to sleep easier at night.
This is an interesting scenario which will take some time to play out, with multiple ramifications from many different angles.
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