Moves to regulate derivatives pose hedging questions
October 20, 2009
by Morton Sosland
Of all the proposals arising from efforts to prevent a recurrence of the economic setback of the past year and a half, none is likely to have greater impact on grain-based foods than steps meant to restrain what is popularly called excessive speculation. While setting caps on salaries of bankers trading highly risky instruments and separating banks’ historical consumer and commercial business from investment banking have provoked debate, it is the effort to regulate the way derivatives trade that might have the greatest consequence.
For an industry that has long used futures exchanges and clearinghouses to hedge against adverse movements in historically volatile grain markets, the idea that would have exchanges take over dealings in derivatives has many aspects requiring careful analysis. Unlike futures exchanges with members, regular margin requirements and clearinghouses in the middle of all trades, derivatives became a multi-billion-dollar business without such an apparatus. Derivatives are a two-party process, thus raising the specter of the counter-party risk, often cited as a cause of recession. It was the ease of dealing with a single provider, usually an investment bank, which led derivatives dealings to become a multi-trillion-dollar business.
The principal participants in derivatives assert that imposing similar rules as used by futures exchanges would so boost costs that dealings would shrink. That means a different way of hedging could be lost, and its impact on futures could be momentous.