Fictional claims for futures July 19, 2013 at 8:45 am

Philip McBride Johnson’s article in FOW has been causing a few heckles to rise. Essentially he claims that the swaps community has only themselves to blame for the higher margin period of risk on OTC derivatives vs. swaps because they claimed that OTC derivatives were different. Legislators, Johnson says, listened, and put swaps in a different category from futures.

What’s interesting about this is that there is a core to his argument that’s correct. Swaps and futures do have some common risk features. The regulatory environment should depend on their characteristics, not their legal form. Some types of swap are very liquid, for instance, and a 5 day margin period of risk might well be conservative for them. Some futures are less liquid, and a one day margin period of risk, as in the US, for them might be generous. But each side has defended its turf: the some in the futures community have been vociferous in their claims for the liquidity of futures, for instance, claims which are not true of all futures, all of the time. To state the obvious, the US regulatory framework here is not exclusively the result of lobbying from the OTC derivatives community.

For me, the clear lesson from this is that it is dangerous to base regulation on form rather than substance. If you can make two different types of transaction do the same thing, roughly, but they have different regulatory environments, then you encourage trading in the less burdened type. Why tilt the playing field? There may be good reasons, of course, but if it is just an accident of typology, that’s unfortunate.

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