Soon Corporations, Energy Companies, Hedge Funds… will be required to participate in the Dodd Frank process if they have material holdings of derivatives. Their response will be overwhelmingly positive, once they understand the Dodd Frank framework and consider current economic conditions.
Current economic conditions are poor globally. Banks are not doing well and should be considered a credit risk. Buy side firms will consider eliminating as much credit exposure to the banks as possible. Dodd Frank makes this possible by converting bank Swap contracts from essentially pure credit instruments to margin (futures like) contracts with a clearing house. Margin should be about 10% of the contract value like futures contract adjusted daily for price fluctuations. Corporations have a lot of Cash and interest rates are at historic lows globally.
In reality, the Sell Side extended free credit for Swaps and charged a spread over the interbank market price when executing customer deals. Dodd Frank only mandated what was already in existence for at least 10 years for Banks and some Buy Side firms. See Below.
Ultimately, most derivative contracts from both the Sell Side and Buy Side will be executed through brokers (Swap Execution Facilities). Transactions would then be cleared and margined at a clearing house (CCP). Transaction data would then be reported to regulators, CFTC and SEC. The Buy Side will probably not elect to take exemptions to clearing. See Below.
Key Buy Side Advantages
- One market for all participants with best price available to all.
- No need to call around the market to get the best price.
- No more Counterparty Credit Risk. CCP is AAA.
- No more Operational Risk.
Technology to hook up the sell side with the brokers and clearing houses has been in place for over 10 years. Joint venture Sungard, ICAP, LCH Clearnet: SunGard eTX Connects With ICAP’s ETC Platform for Trade Execution and Straight-Through Processing | Business Wire | Find Articles at BNET.
SunGard’s and other’s Technology includes significant risk analytics as well support for accounting and regulatory compliance. So, no support staff needed for transaction processing, or accounting. A cash manager needs to be on hand to post collateral and make some wire transfers, and handle bank account reconciliation’s.
It will be now be possible for the CFO to make cash investments, issue commercial paper, execute FX hedges, hedge interest rate risk,hedge commodity risk, buy back stock…Transactions can now be booked in whatever subsidiary makes sense without the need to provide Parental Guarantees or any other accommodations.
Similarly, a hedge fund could be operated solely by a couple of portfolio managers. The technology would deliver risk analytics, accounting, tax, legal, and compliance.
Energy companies could execute hedges electronically in one place or in operating groups. Results would be reported to everyone in operating groups and senior management with the same technology.
Cost of Technology, Brokerage, and Clearing would all be transaction based and calculated on level of service rendered. Annual manpower savings could range upwards from $500,000 . Automating the transactional process from Buy Side customer to a global broker, global clearing house, and global regulatory compliance would be a welcome change for the Buy Side.
How We Can Help
Sagacious LLC is an independent consultant that can Select the Technology, customize your trading process to the Technology, hook things up, make sure everything works, negotiate brokerage agreements, clearing agreements, technology agreements. All financial,accounting, legal,and tax issues would be defined upfront. We will periodically audit and update the trading process. We will also co-ordinate internal and external audits. We could serve as Compliance Officers.
Sagacious LLC’s Qualifications
We were Wall Street traders, Corporate hedgers, Energy traders, Risk Managers, Big 4 consultants, Risk Auditors , and Technologists that have built trading processes and risk management controls that are end to end solutions from transaction execution to booking accounting entries and revising the financial statements. For updates see: SagaciousRisk @Twitter.com and www. BeSagacious.com.
Dodd Frank Is A Blessing
- Streamlines the Derivative trading process.
- Makes the Derivative trading process fully transparent at every step.
- New Derivative products can only be introduced for trading only after everyone understands how they will work and what the risk is.
- A process is in place for Regulatory review of the use of derivative by buy and sell side market participants.
Dodd Frank will make the occurrence of financial disasters from occurring again and saving the tax payers from having to bail out the Derivative trading process again.
Buy Side Participation Should Exceed All Expectations
- Every Corporation, Energy Company, and Hedge Fund will want to be in complete compliance for the benefit and safety of their stakeholders.
- Everyone will want demonstrate
- All market related instruments will eventually added to the process because it will be cost effective not to do otherwise.
- Enterprise-risk management will become the norm.
- Systemic risk will thus decline substantially.