CME Group Well-Positioned to Benefit from Proposed Regulations

This article originally appeared on MedillNewsService.com and was featured in the well-regarded derivatives industry publication The John Lothian Newsletter

CME Group Inc., the world’s largest futures and derivatives exchange, is well-positioned to benefit from Treasury Secretary Timothy Geithner’s proposal to further regulate the over-the-counter derivatives market, according to industry analysts.

The plan, which calls for all standardized OTC derivatives to be cleared through a regulated central counterparty, is being viewed as a boon for the Chicago-based CME, as the requirement will likely push more business to its exchange and OTC platforms.

“This is a huge win for the derivative exchanges that own clearing, including CME given its industry-leading clearing house and large presence in markets dominated by OTC trading,” Kenneth Worthington, an analyst at JPMorgan Chase and Co., said in a research note Thursday.

In the wake of the news, Worthington upgraded his rating of CME’s stock to neutral from underweight.

In his letter to Congress Wednesday, Geithner broadly outlined a regulatory framework for the OTC derivatives markets. He said the new regulation would aim to achieve four objectives including mitigating systemic risk that could be caused by OTC derivatives and increasing the transparency of the OTC derivatives markets.

The U.S. Department of Treasury is in discussions with the Commodities Futures Trading Commission, Securities Exchange Commission and other federal regulators to create a regulatory framework for OTC derivatives that under current law are largely excluded or exempted from regulation, Geithner said.

“The Treasury’s letter represents the strongest-to-date statement made by regulators in advocating a push towards exchange-traded venues,” said Howard Chen, an analyst for Credit Suisse Securities LLC., in a research note Wednesday.

Chen estimated the notional value of the derivatives market to be $766 trillion dollars with 89 percent of that originating through the OTC market.

“The over-the-counter market dwarfs that of the exchange-traded market,” he said.

While CME trails competitor IntercontinentalExchange Inc. in the credit default swaps market, there are still large opportunities for CME in OTC derivatives by taking control of the much larger interest rate swap market.

“CME has a significant competitive advantage going after the interest swap market because it owns the interest rate futures market in the United States,” said Mark Lane, an analyst for William Blair and Company LLC., in a research note Thursday.

Lane said the notional value of the interest rate swap market is between seven to nine times larger than the CDS market.

Shares of CME group closed trading at $284.37 Thursday, up $10.27 or 3.75 percent, from Wednesday’s close, which Geithner’s announcement contributed to, according to Michael Wong, an analyst for Morningstar Inc.

“The markets see a feasible plan going into Congress,” he said.

While analysts agreed that the proposal is a plus for CME, with Lane calling the plan “sensible,” they acknowledge the details of the proposal will be subject to changes by Congress.

“Political wrangling is likely to keep Mr. Geithner’s idyllic view from developing completely,” Lane said.

One area where Geithner’s plan may receive scrutiny is delineating which OTC derivatives should be pushed onto central counterparties, as Lane said the plan stops short of mandating the clearing of all OTC derivatives.

“There are still some opaque-type products, or products that are very complicated, not structured products, that wouldn’t belong on an exchange right now,” CME Executive Chairman Terry Duffy said Wednesday. “The next debate will be what is considered ‘standardized’?”

This entry was posted on Thursday, May 14th, 2009 at 2:19 pm and is filed under Business + Technology and tagged with CME Group, JP Morgan, Morningstar, Terry Duffy, Timothy Geithner. You can follow any responses to this entry through the RSS 2.0 feed.