Back in September, the Chicago Fed hosted a symposium on OTC derivatives clearing. (Bear with me, don’t fall asleep just yet.) The luncheon keynote was given by Ken Griffin, and summarized by Craig Pirrong, who was there:
Griffin gave a paean to central clearing, and to Dodd-Frank more generally. Clearing is cheaper operationally and administratively. It reduces risk. It economizes on capital. It is the cure for all that ails the financial markets.
So if it is so wonderful, what stands in the way of its adoption? Per Griffin: a small, self-interested cabal of dealers who reap billions and billions of profits at the expense of end users, and who will lose their ill-gotten gains in a cleared world.
This narrative is a familiar one, the stock theme of the advocates of central clearing
The NYT’s Louise Story took Griffin’s complaint and elevated it to the status of the main front-page story of the Sunday paper. It’s a long and powerful piece, which alleges that a small group of powerful investment banks are doing their utmost to keep the lucrative OTC derivatives business for themselves; the cabal even has a secret meeting, in midtown Manhattan, on the third Wednesday of every month.
I’m sympathetic to Story’s case here, even if it’s hard to have much sympathy for Griffin, a billionaire who clearly wants to export his high-frequency trading techniques from the stock market to the options and futures markets. I think that Story and Griffin are right that we would be better off with much more derivatives trading centrally cleared, and that the biggest derivatives dealers are doing their best to stymie such a move.
But that said, Story’s story is quite one-sided. She doesn’t talk about Griffin’s profit motive, and she’s far too credulous when it comes to other would-be competitors in the derivatives space. Look at this, for instance:
The Bank of New York Mellon’s origins go back to 1784, when it was founded by Alexander Hamilton. Today, it provides administrative services on more than $23 trillion of institutional money.
Recently, the bank has been seeking to enter the inner circle of the derivatives market, but so far, it has been rebuffed.
Bank of New York officials say they have been thwarted by competitors who control important committees at the new clearinghouses, which were set up in the wake of the financial crisis.
Bank of New York Mellon has been trying to become a so-called clearing member since early this year. But three of the four main clearinghouses told the bank that its derivatives operation has too little capital, and thus potentially poses too much risk to the overall market.
The bank dismisses that explanation as absurd. “We are not a nobody,” said Sanjay Kannambadi, chief executive of BNY Mellon Clearing, a subsidiary created to get into the business. “But we don’t qualify. We certainly think that’s kind of crazy.”
It’s pretty obvious that being founded by Alexander Hamilton in 1784 and being “not a nobody” are not sufficient to be admitted to a central clearinghouse. The way those clearinghouses work, the strongest members bear a lot of risk should one of the weaker members fail, and so it’s reasonable for them to want to try to minimize that risk by forcing members to put lots of capital into their derivatives arms — especially would-be members who think such demands are “kind of crazy”.
So a bit of third-party adjudication would have been welcome here: does BNY Mellon really have so much capital that its acceptance into the derivatives-counterparty club is a no-brainer, as Kannambadi would have us believe? We don’t know: Story simply gives him the last word, and moves on.
More generally, there’s no evidence that Story ever talked to Pirrong or any other third party who takes the other side of the argument. And the other side, as presented by Pirrong in response to Story, does make a certain amount of sense: