The New Wall Street
One positive development, according to Michaels, are the recent actions of Goldman Sachs, which began a hiring binge at its prime services segment earlier this year. "The horizon on the rest of the Street lags about a year behind Goldman. … They wouldn't be hiring people unless they expected a boom," Michaels contends. "And if the hedge fund world booms, along with all that is the proprietary trading groups and the big banks. So the two go hand in hand. They're all trading the same stuff."
Trading volumes in the OTC derivatives market also are poised for a boom due to the reform bill's push for transparency in that space, experts predict. But the desired transparency is unlikely to be achieved anytime soon, and a long process is under way to determine exactly how banks will interact with the CCPs. Still, in the long run, the new mechanism will go far toward bolstering confidence in the market, according to David Gertler, the director of strategic sales at SuperDerivatives, an options pricing firm.
"It's going to take a couple of quarters for everyone to understand what the requirements are," Gertler says. "And then probably a period of time - maybe it's a year or two - to respond to what has been done to accommodate all the transactions that will be handled in a CCP. So it's not going to be an overnight change."
Since the height of the financial crisis, demand has grown sharply for independent valuations and analysis of complex securities whose values aren't necessarily marked to market. Fund administrators dealing in derivatives have amped up scrutiny of pricing, looking to firms such as SuperDerivatives to cull information that can be used in risk management systems, Gertler explains.
"We see expanded interest by fund administrators for more accurate pricing and methodologies - for not just getting the initial price, but for validating prices they may get from their clients," he says. "So I would say that access to good pricing has been one of the greatest things that has been the result of what happened with Lehman Brothers."
Like most corners of the market, SuperDerivatives has seen a slowdown in business since 2008, with an uncertain regulatory environment leading many firms to hold off upgrading operations systems. But with that cloud lifted following the reform bill's passage in July, investment is slowly beginning to pick up, according to Gertler.
"Many of our clients … [are] adding staff and adjusting their existing systems," Gertler says. "But I would say most clients are in the planning stage. Most firms are waiting to see what the regulators are going to say and what's actually going to be implemented."
But while the move to push OTC derivatives onto CCPs is viewed as a step in the right direction, at least one expert warns that this strategy may be planting the seeds for the next financial crisis. CCPs, which raise money by collecting funds from market participants, would be in jeopardy if the losses on a bankrupt counterparty were to exceed that margin, Jon Gregory, the former head of credit quantitative analytics at Barclays Capital, argues in a research paper released in May.
"CCPs and their counterparts must therefore also be concerned that there is adequate coverage of losses due to the default of a member following a margin-depleting price move," Gregory wrote. "Since the reserve fund is likely to only be moderate, then severe cases will lead to additional contributions from CCP members, other support, or will cause failure of the CCP itself."
And while regulators have stepped in to curb the concept of a "too big too fail" financial institution, Gregory contends, CCPs actually may turn out to be the next AIG. "Although CCPs reduce counterparty risk for market participants, funneling market activity through one institution leads to a concentration of risk," he explained in the paper. "Since CCPs limit the risks to other market participants, their own failure becomes a critical component that would potentially lead to a systemic event." As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio
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