Oil Energy Money has already discussed the counterparty risks discouraging traders from entering contracts with banks. Now, the $9 trillion off-exchange (over-the-counter) market is transforming to reduce default risks.
Before the financial crises, the chance of a blue chip bank going bankrupt and reneging on transactions was a small risk to pay for the benefits of over-the-counter deals. Complex swaps could be created with irregular expiry dates and size. OTC trades didn’t have to be announced and the transaction costs were low. The number of transactions was much fewer than trades on exchanges like NYMEX, but the total dollar value was much larger.
Now, traders are moving away from such complex products and turning to vanilla contracts which can be easily traded on the exchange. “You’re going to see an avalanche of trading taken out of the OTC market,” said Michael Korn, a broker at Skokie Energy Corporation. Other trades may remain OTC but enter a clearing house such as NYMEX Clearport. A clearing house operates as a middleman between buyer and seller, ensuring payment and goods are received by the respective parties. In exchange for taking on this risk, the clearing house usually charges a fixed fee plus a percentage of the trade value.
Volumes through Clearport have risen 35% since the start of 2008 and in the third quarter were 41% higher than the third quarter of last year. This should create a more transparent market for trading, increasing the amount of information available. At a time when many Americans are worried about increasing domestic fuel prices, this oversight should prevent profit gouging.
The transformation from OTC to clearing houses may be good news in a wider sense. It implies traders are moving towards safer trades without government regulation. The self-regulating effect Alan Greenspan hoped would efficiently run Wall St. may still exist. But there are still more pitfalls than safe havens. “People are worried about counterparty risk, so if you don’t clear your OTC deal you are simply relying on your counterparty to perform,” says Christopher Bellew, a broker at Bache Commodities. “In these troubled times, that’s not a given.”
