Futures Exchanges Talk Derivatives Reforms While Europe Burns

June 27th, 2012 by Trefis Team
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The European derivatives markets are ready to shake off the blues as the world’s leading futures exchanges meet at the International Derivatives Expo in London this week to discuss opportunities and reforms in over-the-counter (OTC) swaps clearing. [1]

OTC trading has long been a concern for authorities as swap trades are carried out privately between parties without the intervention of an exchange and are largely unregulated. The lack of transparency while trading was one of the reasons that led to the financial crisis in 2008, and policy makers have since been vying for changes to overhaul the market regulations.

Unlike shares and futures trades, OTC trades currently do not require clearing houses to regulate and step in to compensate the risk of settlement failure in case of a default by one of the parties. This trend however is set to change as politicians and regulators are unanimous in their opinion regarding the requirement for clearing houses while trading in the OTC markets. OTC clearing opens up a huge window of opportunity for exchanges as trade volumes for traditional exchange-listed products have been mostly subdued as uncertainty reigns over the fate of the European markets.

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Morgan Stanley (NYSE:MS) said in a report earlier this year that OTC clearing provided a $3 billion revenue opportunity and exchanges are queuing for a slice of the pie. CME Group (NASDAQ:CME) is set to launch a credit derivatives trading platform in Europe this year and Nasdaq OMX has recently unveiled plans to launch a new interest-rate derivatives trading platform in London (NASDAQ:NDAQ). [2]

See our full analysis for Nasdaq OMX| NYSE Euronext|CME Group| Morgan Stanley

New House Rules

The European Securities and Markets Authority (ESMA) published draft rules, earlier this week to increase transparency in the derivatives market. [3] The rules, open to public scrutiny, provide a framework to guide banks engaging in OTC trading and will be finalized in September, this year. Clearing house operations are defined, along with standards for contracts that require clearing, to ensure the completion of a transaction, even if one side defaults. Thresholds for five derivatives classes have also been introduced, below which clearing will not be required.

The European Union’s securities watchdog’s announcement coincided with Nasdaq’s decision to enter the European market. The exchange, still reeling from the Facebook (NASDAQ:FB) IPO fiasco, (See Facebook’s Relationship Status With Nasdaq: It’s Complicated) announced plans to launch a new derivatives platform named Nasdaq OMX NLX in London, by the first quarter of 2013.

The exchange will look to break the duopoly help by NYSE Euronext’s (NYSE:NYX) Liffe and Deutsche Boerse AG’s Eurex, which currently dominate the European derivatives market. The NLX platform will offer short-term and long-term listed interest rate listed derivatives products and clear through LCH.Clearnet Group Ltd. The single platform trading capabilities are likely to attract investors and hedgers who seek to offset risk in both ends of the yield curve with long and short-term debt securities.

We will keep a close eye on the derivatives market in Europe, which are in for an interesting time with an imminent bailout in Spain [4] and a pro-austerity result in the Greece elections [5] likely to effect the region’s economy. Nasdaq’s European operations currently account for just 2% of our price estimate, but this is likely to increase with the new venture by the company.

We have a price estimate of $26.54 on Nasdaq OMX’s stock, about 25% above the current market price

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Notes:
  1. PREVIEW-Futures exchanges gear up for regulatory reforms, Reuters, 25th June, 2012 [↩]
  2. Nasdaq unveils European derivatives ambition, Market Watch, 21st June, 2012 [↩]
  3. EU watchdog publishes draft derivatives rules, 4-Traders, 25th June, 2012 [↩]
  4. Spain full-blown bailout all, but inevitable: Analysts, Economic Times, June 21st, 2012 [↩]
  5. Greece election results: Pro-bailout parties look to forge coalition, Economic Times, June 18th, 2012 [↩]