The Challenge of Creating the New Derivatives Market

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When you visualize the stock market, you may imagine lots flashing flat screen monitors and screaming traders wearing telephone headsets. Stock trading these days is sophisticated and robust. Indeed, computers even perform a large number of trades automatically. But the market for over-the-counter derivatives such as credit default swaps isn't as sophisticated. The summer's giant financial regulation bill ordered that they must be cleared and exchange traded, when possible. That won't be easy, as an entirely new infrastructure must be created from scratch.

This challenge was discussed at a Securities Industry and Financial Markets Association conference this week. Tom Steinert-Threlkeld, writing for the Securities Technology Monitor, quotes Annette L. Nazareth, a partner of the law firm Davis Polk & Wardwell:

"This is something that is going to be a huge operational and technology challenge," she said.

Market participants will have to build all the elements of execution and regulation "that you take for granted in equity markets," she said.

This will include systems for regulating intermediaries, regulating exchanges, regulating clearing houses, reporting trades, sending reports on trades to information repositories, identifying swaps that can be traded and those that can't, and capturing data on each swap, for starters.

Of course, this new infrastructure comes with a cost. Countless hours will be spent on projects, not to mention additional equipment of software needed by firms who hope to trade derivatives through these new mechanisms. Derivatives will become more expensive.

Read the full story at the Securities Technology Monitor.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.
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