Volume has soared again and the credit correlation market disruption of April and May produced hedge fund and bank proprietary dealing losses without prompting the withdrawal from the market of any significant players.
Regulators have steadily increased the pressure on dealers and funds to tackle operational deficiencies in the credit derivatives market, but supervisors seem satisfied by the response to their public expressions of concern, at least from banks.
Equity derivatives specialists are set to break earnings records this year, credit derivatives trades continue their exponential rise and flat yield curves have failed to cause a collapse in rates derivatives activity.
This is translating into a compensation bonanza in OTC markets.
Experienced equity derivatives sales and structuring staff have been able to name their own prices, as new entrants seek to break into the market. The value of staff with a combination of credit market experience and modelling ability has also shot up. Only interest-rate derivatives specialists run a risk of feeling unloved at bonus time, and even there many traders have made a shift towards proprietary dealing that should stand them in good stead, as long as they called key curve shifts right.
Listed derivatives market returns have been complicated by the Refco scandal.
The Chicago exchanges did not just fend off their near-death experience by going electronic, they also sent Eurex packing this year, set new volume records almost monthly, and made many of their members temporarily extremely wealthy with the rise in the CME share price and the corresponding pre-IPO rise in the value of the CBOT.
The scandal engulfing futures and commodities broker Refco has reduced the economic value of the Chicago exchanges and also underscores the binary nature of reputational risk.
Refco’s stock collapsed because of fraud, not its core derivatives and commodities broking activity, but uncertainty about the extent of financial malpractice at the firm seems set to reduce further the value of other futures industry participants, even if they see a pick-up in volume as business is transferred from Refco.
Apparently unrelated problems may also spill over into a change in attitude from regulators towards the OTC derivatives industry. The effect of moral suasion from regulators on credit derivatives market
participants was widely lauded when a road map for operational improvements was agreed in early October.
But it will only take one breakdown in credit derivatives market practice for this to change. If hard-fought consensus on changes to settlement after credit events such as the Delphi failure were to devolve into litigation, regulators could quickly change their tone.
That in turn could put a serious dampener on the structured credit party of recent years, just as underlying credit conditions are likely to worsen next year.
And Alan Greenspan won’t be around to act as public defender of last resort for the derivatives industry.