WEDNESDAY, MAY 5, 2010

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Financial overhaul likely to benefit clearinghouses

Chicago Mercantile

ty or a bond. Since the late 1990s, they also

Exchange could be among beneficiaries

by Robert O’Harrow Jr.

The effort to overhaul financial

regulation, aimed in part at im- proving oversight of complex de- rivatives 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 de- pend 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 At- lanta-based IntercontinentalEx- change (ICE), a futures exchange that has become the most suc- cessful 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 deriva- tives, interest-rate swaps. “The established clearing op-

erations, such as CME and ICE, are seen as the natural beneficia- ries,” said Dan Fannon, managing director at Jeffries & Co., an in- vestment-banking firm. The overhaul efforts are aimed

at creating control over the vast and often unregulated market for derivatives — the uncounted pri- vate contracts that came to be worth about $600 trillion before playing a crucial role in accelerat- ing the global financial melt- down.

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 oc- curring in the future, such as the performance of an underlying as- set such as a commodity, an equi-

Chicago Fed is faulted on oversight

Bloomberg News

The Federal Reserve Bank of

Chicago failed to halt speculative real estate lending that led to loss- es at banks in Indiana and Michi- gan that were later closed, the central bank’s inspector general said.

Columbus, Ind.-based Irwin

Union Bank and Trust almost tri- pled in size from 2000 to 2005 as it extended credit to subprime mortgage borrowers with insuffi- cient collateral, Fed Inspector General Elizabeth Coleman said in a report. Chicago Fed supervi- sors missed “multiple opportuni- ties between 2002 and 2009 to take additional and stronger su- pervisory actions,” the report said.

At Warren, Mich.-based Warren Bank, early supervisory action by the Chicago Fed could have re- duced the cost of the ultimate fail- ure, blamed on excessive concen- tration in commercial real estate, Coleman said in a separate report. Both banks were closed last year. The findings, dated April 29 and posted on the Fed’s Web site, follow similar criticism last year of supervisory flaws at the Atlanta Fed. The chairman of the Senate banking committee, Christopher J. Dodd (D-Conn.), is leading an effort to scale back the Fed’s su- pervisory powers, saying the cen- tral bank failed to curtail risky lending practices that contribut- ed to the collapse of the housing market. The measure is part of a proposed overhaul of financial regulation under debate in the Senate. Reports by the inspector gener- al last year criticized the Atlanta Fed’s supervision of Riverside Bank of the Gulf Coast in Cape Coral, Fla., and First Georgia Community Bank in Jackson, Ga. Fed governor Daniel K. Tarullo is leading an overhaul of exam- inations by the central bank, aim- ing to identify potential threats across the banking industry. While supervising commercial banks, Fed district banks process checks and report on regional business conditions. Irwin Union Bank’s failure re- sulted in an estimated loss to the FDIC’s deposit insurance fund of $552.4 million, or 20.5 percent of the bank’s $2.7 billion in total as- sets. Warren Bank’s failure result- ed in an estimated loss to the FDIC of $276.3 million, or 52 per- cent of the bank’s total assets of $530.9 million.

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have been used by speculators as a form of betting. As some derivatives became more complex, and more en- twined with exotic securities, the risks they posed became essen- tially unknowable. The legislation, known as the

Wall Street Transparency and Ac- countability 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 con-

templates 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 compe- tition among those buying and selling derivatives.

Patrick O’Shaughnessy, an ana-

lyst 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 conclu- sion.”

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

The Chicago Mercantile Ex-

change has long been a global trading center for futures con- tracts, a type of exchange-trade derivative. The exchange went public almost a decade ago. Three years ago, it merged with the Chi- cago Board of Trade. It also began trying to build its interest-rate and credit-default- swap business, with mixed suc- cess, 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 facil- itate business-to-business deriva- tives deals involving energy, met- als and other commodity-based products. That means that some invest- ment 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 be- tween buyers and sellers of inter- est-rate swaps and other deriva- tives contracts.

oharrowr@washpost.com

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