OTC and Exchanges: Convergence Deferred; Five Years Ago, the Promise of Commoditization and Real-Time Processing Created an Expectation of a Renaissance in Listed Product Development. Alas, Only a Handful of Products Were Developed, and They Were Underwhelming. but the Expected Convergence of OTC and Exchange Markets Is Gearing Up Now

By Zwick, Steve | Futures (Cedar Falls, IA), November 2007 | Go to article overview

OTC and Exchanges: Convergence Deferred; Five Years Ago, the Promise of Commoditization and Real-Time Processing Created an Expectation of a Renaissance in Listed Product Development. Alas, Only a Handful of Products Were Developed, and They Were Underwhelming. but the Expected Convergence of OTC and Exchange Markets Is Gearing Up Now


Zwick, Steve, Futures (Cedar Falls, IA)


Richard Olsen and his partner Michael Stumm built the Oanda trading platform in part to show it was doable, and in part because they truly seem to believe that if you get more people participating in open, transparent and liquid markets, you'll end up with the kind of fair and stable financial system that markets are supposed to deliver.

Contrast that with the over-the-counter (OTC) world, where a few well-educated, but not particularly diverse, minds are determining the prices on which trillions of dollars worth of global instruments are based.

A cynic would blame the top-tier banks that run everything and keep the markets closed and clunky to bloat the bid-offer spreads that generate their profits.

Someone less jaded might argue that closedness and clunkiness are necessary traits of the OTC beast, which is no beast at all, but rather a sort of financial market Miles Davis or Kurt Cobain--a cantankerous and temperamental genius, whose idiosyncrasies we willfully tolerate to enjoy the benefits of their work.

Olsen says their value has been greatly exaggerated.

"If you have one group of people who all read the same newspapers and all go to the same restaurants agreeing on a price," he says, "you get a price that can go to completely unreasonable levels, and eventually the bubble will burst, and that's what's happening now."

The price he's referring to, of course, is that of credit default swaps (CDS) and other credit-default instruments, but the analysis can be applied to all markets dominated by OTC transactions.

WISE CROWDS?

His point touches on several fascinating debates, chief among them being whether broader participation in the pricing of such instruments would have prevented, or at least minimized, the current credit debacle.

"I don't think you can say the whole credit crisis would have been averted if people were trading credit products on-exchange," says Eurex Product Strategy boss Brendan Bradley. "Only a small percentage of credit instruments are suitable for exchange trading now, and most of the structured instruments out there never will be."

Rick Redding, the Chicago Mercantile Exchange's director of products and services, agrees, but adds that time has a way of commoditizing some fairly obtuse instruments.

"Weather derivatives are a case in point," he says. "These were pure OTC instruments until we launched our futures contracts, and now both products are doing well."

HEDGOCRACY

Credit default products have been launched by exchanges from Frankfurt to Chicago, beginning in March with Eurex's launch of Itraxx Europe credit default index futures and its sub-index, Itraxx HiVol, as well as Itraxx Crossover.

So far, however, all have failed to attract significant volume and the HiVol hasn't traded at all despite that OTC traders themselves are more and more using credit default indexes like Itraxx to benchmark their risk.

Common wisdom says the big banks have simply not used their credit books to support the products because they fear a successful exchange-traded index would lead to exchange-traded single-name products--and single-name products generate the fattest margins.

Bradley, however, says it's more likely that investment banks have just moved on to greener pastures, and points out they also make their margins in second- and third-generation products such as index tranches and Constant Proportion Debt Obligations (CPDOs), which involve swapping baskets of high-risk and AAA debt with complex guarantees with issuers in the event something goes sideways.

Redding adds the day will come for credit default futures as more and more hired guns leave the big banks and join the buy side.

"The markets are evolving, and a lot of the people who designed these products at the big banks are now setting up hedge funds," he says. "These are people who are used to structured products and they also know how to break them down into their components--which is where you find the commoditization. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • A full archive of books and articles related to this one
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

OTC and Exchanges: Convergence Deferred; Five Years Ago, the Promise of Commoditization and Real-Time Processing Created an Expectation of a Renaissance in Listed Product Development. Alas, Only a Handful of Products Were Developed, and They Were Underwhelming. but the Expected Convergence of OTC and Exchange Markets Is Gearing Up Now
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

    Already a member? Log in now.