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Foreign Exchange

Dodgy derivatives: One-size-fits-all approach to OTC derivatives

I had to let out a really loud groan this week when I read about plans by the Obama administration to, as Reuters put it, “exert more control over the shadowy over-the-counter derivatives market, now closely linked to the global credit crisis”.

Reuters added: “The plan, sketched out by Treasury secretary Timothy Geithner and top regulators at a news conference, marks a big step in the administration's push to rewrite rules for banks and financial markets in response to a credit crisis that has sent economies around the globe reeling.” And sketched out seems an apt description of what, for the moment, looks like an exceptionally sketchy scheme and one that has brought back to life many of the old clichés about dodgy derivatives. “Over-the-counter derivatives are presently difficult to monitor and supervise. Billionaire investor Warren Buffett has called derivatives ‘financial weapons of mass destruction,’” Reuters points out.

The problem seems to be that this initiative is trying to take a one-size-fits-all approach to all OTC derivatives, which includes interest-rate swaps and FX. According to the Bank for International Settlements, the notional value of the over-the-counter derivatives market was $683 trillion at the end of June 2008. Swaps accounted for $458 trillion of that, with FX products accounting for $63 trillion. Credit derivatives, which are really what is being targeted, constituted $57 trillion.

My initial thought was that the lobbyists employed by the exchanges have really earned their pay.

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