Tuesday, October 21, 2008

Chicago can't risk losing swaps trade

(Chicago Tribune) For decades now, civic boosters have positioned Chicago as the "risk management capital of the world."

As catch phrases go, it's not exactly "hog butcher to the world." But with banks facing bailouts or burials and the stock market gyrating like a downed power line, "risk management" is now an easy-to-grasp topic.

For Chicago, risk can be the city's own reward. The new world of global financial risk can create opportunities for those who professionally manage them.

It's not all upside, though. Competitors may move in if the new challenges are not ably met here. Expertise and opportunity could be lost in Chicago.

The newest front in this battle is in a market sector as inscrutable as it is important: Credit default swaps.

"Credit default whats?" you might be asking. Don't worry. It's less important to know the intricacies of such arcana than the potential impact of the battle over them.

While it may dazzle dinner-party guests who hear you explain that these contracts allow companies, bankers, investors and others to buy and sell—"swap"—the risk of default on a corporate IOU, it's best to refrain from such showmanship. Instead, focus on the essential knowledge: that Chicago jobs and the city's standing in the financial world are on the line in the battle over how the swaps will trade.

Two big Chicago outfits, CME Group and hedge fund firm Citadel Investment Group, are banding together to offer to clear the trading of credit default swaps. They would match buyer and seller, guaranteeing that both would have the financial strength to stand behind their trades.

Contesting the CME-led effort is one by The Clearing Corp. in partnership with the IntercontinentalExchange. A European group is also in the fray.

The Clearing Corp. is headquartered in Chicago. But its bid essentially is run by swaps dealers themselves.

Swaps dealers don't want the Chicago futures giant to get a toehold into their lucrative business. Let the CME start with clearing, their thinking goes, and before long CME will begin offering trade execution. Then it will begin designing its own swaps contracts for sale.

When CME bought the Chicago Board of Trade last year, executives did gush about the potential for swaps and other over-the-counter derivatives.

Action did not follow that talk. Indeed, executives who run Chicago's futures exchanges have talked for more than a decade about the potential for the swaps business, but never backed that up with any meaningful action.

Now that everyone recognizes the potential—and the danger—of a credit default swaps market that is made up of contracts with an implied value of $50 trillion, competition will be stiff. Regulators at the Federal Reserve and the Commodity Futures Trading Commission will want a say in where this market goes.

Not enough detail has emerged to say whether the CME Group or its rivals will control this market.

"There's just no way of knowing who will be the Wal-Mart of this business: Who is going to be the most dependable, lowest-cost provider," said Henry Hu, a law professor at the University of Texas who is expert on swaps regulation.

The CME can boast about its ability to run a global marketplace and its record of successfully clearing trades through market breaks such as the 1987 stock-market crash. It can energize a well-oiled lobbying machine in Washington and use Citadel's fresher but still powerful political connections.

Talk is cheap, though. Action and the ability to build a new marketplace ultimately will decide whether Chicago can further advance its role as a risk-management powerhouse.

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