LSE Could Win in Shake-Up of Derivatives

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Byline: Simon Watkins TAKING STOCK

THE crisis that has rocked the City and every other financial capital over the past year has led observers and regulators to peer into some of the darker nooks and crannies of the financial system and ponder what has been going on. And they don't get much darker than the over-the-counter derivatives market.

But this market is at the centre of the reshaping of the financial system, including some of London's most notable finance firms, such as Icap and the London Stock Exchange.

Derivatives are the complex instruments that enable companies to insure against changes in interest rates, firms not paying their debts, currency movements and so forth.

The phrase 'over the counter' refers to trading that takes place privately between finance firms. No one on the outside knows what trades have taken place, let alone at what price. The go-betweens in the OTC markets are the interdealer brokers, the leading UK examples of which are Icap and Tullet Prebon.

The recent volatility in the markets is good for them and Icap and Tullet shares have outperformed the stock market hugely in recent weeks. Icap's results, due on Tuesday, will show sales of just over [pounds sterling]1.5 billion and profits of more than [pounds sterling]330 million.

The cloud on the horizon is that OTC credit derivatives (gambles on whether debtors will repay what they owe) have been blamed in part for the financial crisis. …