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September 1, 2012

CQ&D Cover Story: Hang On Help is on the Way!

Many expect a revenue spike in Some clearing-related businesses

By Gregory Bresiger

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It just can't get any worse. Falling broker-dealers that couldn't hack it, firms that died or were swallowed. Margin business ruined by uncommonly low interest rates. And those rates guaranteed by the Federal Reserve to stay dirt cheap for at least for another year. Transaction volume-the mother's milk of the clearing business-is lagging.

Numerous clearing broker executives and industry observers have pointed to all of this over the past few years, as the business has slumped.

"It's a business built on volume. But volume has been down for the past three years," said Sang Lee, a clearing industry analyst with Aite Group. "And there is no immediate prospect of volume going up." 

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"Times seem to be at their worst," concurred Craig Gordon, a longtime clearing veteran with RBC.

But maybe not.

Some industry observers say there are at least two hopeful factors in the near term-besides the obvious one, a potential volume comeback. These two factors would provide a rosy scenario for both parts of the clearing industry, the institutional business and retail.

For institutional clearing, the hope is the renewed promise of over-the-counter derivatives, a type of business that, prior to this, has infrequently gone through clearing.

But regulators are now pushing this kind of business-business in the trillions of dollars-the clearing industry's way. The Bank for International Settlements says the notional value of all of it is in excess of $700 trillion.

The clearing of OTC derivatives also represents a fabulous new source of potential revenues. Until recently, the clearing industry largely has been bypassed. But now, thanks to U.S. lawmakers, it could receive a huge amount of the business. It is so big because these contracts, which include credit default and interest rate swaps, are very popular with big businesses that need to hedge risk. 

Sang Aite

Indeed, 94 percent of the world's 500 largest companies use derivatives to manage their risk, according to the International Swaps and Derivatives Association.

Many of these transactions, which were once done privately, will be going though dealers with clearing arms, clearinghouses and CCPs for the first time over the next few years. That's owing to the Dodd-Frank Act, the financial reform law of 2010.