OTC derivatives reform has become synonymous with shrinking dealer profits. Automation will shrink spreads, clearing will raise costs and central clearing will erode this control of the market. But there is another side to the reform story, one of wide-eyed entrepreneurs who see huge opportunities in the expected market revamp. In addition to the more obvious opportunities for clearinghouses, exchanges and inter-dealer brokers, many software firms, consultancies, hedge funds, proprietary trading firms and up and coming dealers are well positioned to reap huge profits over the next few years. Many will make short term profits from the current pandemic of fear, uncertainty and doubt, and a smaller few will see long term growth and profit at the center of an OTC derivative market brought into the twenty first century.
Although the bill passed in the US House of Representatives in December 2009 and proposed legislation from the European Union does notmandate automation of the OTC derivative market, it certainly sets the stage for a move in that direction. Central clearing and a requirement to execute certain orders through a registered entity will require new connectivity, new bi-directional data feeds, updated collateral management software and reworked risk models. This is a boon for technology providers who have been pushing products to automate the OTC derivatives market for years.
Read the rest of my perspective at TabbForum (free registration)