The Options Clearing Corp. (OCC), the dominant player in exchange-listed options, is looking to expand into clearing OTC options and other derivatives.
The OCC is now "seriously" looking at clearing OTC derivatives contracts because clients have asked them to do it, an OCC spokesman told Traders Magazine.
"The OCC has been looking at clearing OTC options for the past several months," says spokesman Jim Binder. But there are no current plans to forward a proposal to the board, which is comprised of representatives of big buyside firms and options exchanges. Binder said that the current examination of new areas of business for the OCC includes other derivatives like swaps. "We are still in the exploration process," he added.
"People trust in the strength of our CCP model," Binder says. He says the OCC is recording some 14 million contracts daily. That’s up some 5 percent from the beginning of the year. The 14 million number is about the same as it was recording a year ago. The OCC is a clearinghouse that has "100 percent" of all U.S. exchange listed options, he adds.
So why should the OCC seek OTC business?
OTC derivatives business, which is about half of the listed market, is growing faster. According to the Bank for International Settlements, over the last decade the notional value of listed contracts grew three fold. At the same time, the OTC’s notional value rose four fold. The listed market remains bigger than the OTC, according to a year-end Standard & Poor’s report. The listed business had about 1.95 trillion in notional value. The OTC had some $986 billion.
Binder says the CFTC and SEC already regulate the OCC. So, in adding OTC business to its menu, it may or may not need regulatory approval. However, OCC is already through that first hurdle because it is a recognized clearing house by both regulators, Binder said.
He adds that the OCC board would again review the OTC issue sometime this year. Citing technology issues, he wasn’t sure how long it would take for OTC clearing to begin, if approved.
"We would begin by doing equity OTC contracts first," Binder says. "It would be more a business than a regulatory decision," he added.
Maybe.
But the decision would also come at a time when regulators will be issuing new derivatives trading rules. Derivatives and hedging are vitally needed for many clients in the public and private sectors. Still, many financial institutions were spooked by last year’s market derivatives disasters. For example, some bad derivatives bets led Jefferson County, Alabama, to the verge of bankruptcy.
So the Obama administration is working on new rules that would lessen anxiety about these contracts. The problem is what some fear is a kind of Gresham’s law of trading: Bad parties to a trade will destroy good parties.
So some today won’t touch any sort of derivatives even though they could be useful in a bear market. What could change that?
Industry observers say that stronger CCP clearing models, with more effective risk management tools, would reduce this fear.
Indeed, in a letter last month to the New York Fed, regulators were asked to improve the OTC infrastructure. The letter was signed by most of the major dealers and buyside institutions. It called for regulators to require stronger CCPs.
"We fully understand and support that CCPs will be regulated with particular emphasis on financial strength to absorb market shocks including the bankruptcy of a major market participant," the firms wrote. The letter was signed by Goldman Sachs and JPMorgan Chase, among others.
Why is a better CCP model so important?
Regulators, notes TowerGroup derivatives industry analyst Stephen Bruel, now regard clearing "as an important risk mitigation tool."
