UPDATE: OTC Derivatives Clearing Opens Doors For Fund Mgrs
June 26 2009 - 4:02PM
Dow Jones News
An Obama administration plan to shift over-the-counter financial
derivatives into clearinghouses opens the door for a host of new
hedge-fund trading strategies, and more managers are laying plans
to incorporate the instruments into their portfolios.
The move by exchanges to standardize OTC products such as credit
derivatives and interest-rate swaps, a precursor to central
clearing and exchange trading, makes the instruments palatable for
a wide swath of hedge funds and commodity-trading advisers that
prefer standardized products for their liquidity and price
transparency.
"It's a whole new frontier for us," said Craig Caudle, chief
executive of Liberty Funds Group Inc., a managed futures-focused
firm that oversees about $120 million.
Many hedge funds are already heavily involved in OTC markets,
but other firms such as Liberty restrict trading to on-exchange
products that are easier to trade and don't carry counterparty
risk.
That universe is expanding with efforts to move over-the-counter
instruments onto exchange-backed clearing services, and Caudle said
he's been keeping a close watch on the new products being added to
CME Group Inc.'s (CME) ClearPort platform, which provides central
counterparty clearing for bilateral OTC trades.
As market participants warm to the idea of clearing their OTC
business - with a push from Washington, which views clearing as a
means of reducing systemic risk in off-exchange markets - exchanges
such as the CME, IntercontinentalExchange Inc. (ICE), Nasdaq OMX
(NDAQ), NYSE Euronext (NYX) and Deutsche Boerse (DB1.XE) have moved
to provide clearing for an ever-expanding array of instruments.
CME's ClearPort has added more than 175 new products to the
ClearPort platform this year alone, including swaps on corn,
electricity and natural gas; the exchange is also planning to clear
credit derivatives and interest-rate swaps.
"When you talk about being able to trade everything from a
credit default swap to a grain swap, I think it's a great
opportunity, especially for people that are quantitatively oriented
because you can apply your rules across a greater spectrum," Caudle
said.
Justin Dew, senior managing director of Welton Investment Corp.,
said the lack of liquidity and price transparency in credit
instruments has kept the $500 million managed futures and global
macro firm on the sidelines, but that may change.
"If there's liquidity in credit default swaps, and [the market]
moves and you can trade it, we'll be there," said Dew, speaking on
the sidelines of the Managed Funds Association Forum in Chicago
this week.
Dew welcomed the push by regulators and exchanges to standardize
over-the-counter products. "It opens up new markets," he said.
"It's nothing but good."
Some managers remain leery of off-exchange products. Ken
Armstead, partner and chief investment officer of Absolute Plus
Management, said his firm does just fine trading on-exchange
products in a variety of asset classes, and that won't change
anytime soon.
"There's enough opportunities in the liquid, transparent markets
that are very harvestable," said Armstead, who also attended the
MFA event. "Our focus has always been on liquidity and
scalability."
Armstead pointed out that transparency can be a "double-edged
sword" for investors who follow OTC products as they migrate onto
centrally cleared platforms.
With more price transparency, traders could see profits in OTC
trading shrink, and overall volume in the market may decline, he
said.
Investment banks that have been making markets in the
over-the-counter sector would also see margins hit by increased
liquidity and standardization, according to Andy Awad, a principal
at research firm Greenwich Associates.
Howard Simons, a strategist at Chicago-based Bianco Research,
said traditional trading strategies in over-the-counter markets
will probably dry up as a deeper, more liquid market frees up the
flow of information and invites more participants.
Simons said he saw the potential for other hiccups ahead as OTC
markets standardize and evolve, which could bring further scrutiny
from lawmakers and regulators.
Lawmakers this week took aim at commodity markets after a Senate
panel report attributed a run-up in wheat futures prices to
commodity index funds, alleging that rampant speculation in wheat
futures caused a dislocation in the market.
"Inevitably when you expand trade...you'll find instruments get
applied to uses for which they were not intended," Simons said.
"There will be bumps and bruises along the way."
-By Jacob Bunge, Dow Jones Newswires; 312-750 4117;
jacob.bunge@dowjones.com