Derivatives Dealers’ Club
Robert E. Litan of The Brookings Institution coined the nickname “derivatives dealers’ club” in his April 7, 2010 paper: “The Derivatives Dealers’ Club and Derivatives Markets Reform: A Guide for Policy Makers, Citizens and Other Interested Parties.” The “club” is an oligarchy of large banks who deal in derivatives and try to keep other players out of the derivatives game. The derivatives field has been largely unregulated and members of the “derivatives dealers’ club” have been able to collect large (and usually undisclosed) fees from its clients.
The name “derivative dealers’ club” was used in a news article in the December 12, 2010 New York (NY) Times: “A Secretive Banking Elite Rules Trading in Derivatives” by Louise Story. There have been several federal government initiatives to break up the “club” that few can join.
Brookings Institution
The Derivatives Dealers’ Club and Derivatives Markets Reform: A Guide for Policy Makers, Citizens and Other Interested Parties
Financial Institutions, Financial Services, U.S. Economy
Robert E. Litan, Senior Fellow, Economic Studies
The Brookings Institution
April 07, 2010 —
Mention the word “derivative” outside of a narrow circle of Wall Street and Chicago traders and other market participants, and you’re likely to get one or several of the following reactions: fear, anger, or disinterest. Warren Buffett has famously analogized derivatives – financial instruments whose value depends on and thus is “derived” from the value of some other underlying security, such as a stock or a bond or the current price of a commodity – as “financial weapons of mass destruction.” Who wouldn’t be afraid of such things? Or, if the widespread condemnation of derivatives for causing or helping to cause the recent financial crisis is accurate, who wouldn’t be angry at them? Meanwhile, those who might not care about the word or the complex issues it raises can be forgiven. After all, derivatives are difficult for non-experts to understand and seem unrelated to every day things most people really care about in times like these – such as their jobs and how they will be able to pay for their children’s education or their own retirement.
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I have written this essay primarily to call attention to the main impediments to meaningful reform: the private actors who now control the trading of derivatives and all key elements of the infrastructure of derivatives trading, the major dealer banks. The importance of this “Derivatives Dealers’ Club” cannot be overstated. All end-users who want derivatives products, CDS in particular, must transact with dealer banks. The dealer banks, in turn, transact heavily with each other, to hedge the risks from their customer trades and somewhat less frequently, to trade for their own accounts.
I will argue that the major dealer banks have strong financial incentives and the ability to delay or impede changes from the status quo - even if the legislative reforms that are now being widely discussed are adopted - that would make the CDS and eventually other derivatives markets safer and more transparent for all concerned. At the end of this essay, I will outline a number of steps that regulators and possibly the antitrust authorities may be able to take to overcome any dealer resistance to constructive change.
The Baseline Scenario
“The Derivatives Dealers’ Club”
By James Kwak
April 14, 2010 at 11:32 am
Robert Litan of Brookings wrote a paper on the derivatives dealers’ club — the small group of large banks that control most of the market for certain types of derivatives, notably credit default swaps. It’s a blunt analysis of how these banks can and will impede derivatives reform in order to maintain their dominant market position and the rents that flow from it.
I haven’t had time to do it justice, so I recommend Mike Konczal’s analysis in parts one and two (but particularly one). As Konczal says, “In case you weren’t sure if you’ve heard anyone directly lay out the case on how the market and political concentration in the United States banking sector hurts consumers and increases systemic risk through both political pressures and anticompetitive levels of control of the institutions of the market, now you have.”
New York (NY) Times
A Secretive Banking Elite Rules Trading in Derivatives
By LOUISE STORY
Published: December 11, 2010
On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan.
The men share a common goal: to protect the interests of big banks in the vast market for derivatives, one of the most profitable — and controversial — fields in finance. They also share a common secret: The details of their meetings, even their identities, have been strictly confidential.
Drawn from giants like JPMorgan Chase, Goldman Sachs and Morgan Stanley, the bankers form a powerful committee that helps oversee trading in derivatives, instruments which, like insurance, are used to hedge risk.
In theory, this group exists to safeguard the integrity of the multitrillion-dollar market. In practice, it also defends the dominance of the big banks.
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None of the three clearinghouses would divulge the members of their risk committees when asked by a reporter. But two people with direct knowledge of ICE’s committee said the bank members are: Thomas J. Benison of JPMorgan Chase & Company; James J. Hill of Morgan Stanley; Athanassios Diplas of Deutsche Bank; Paul Hamill of UBS; Paul Mitrokostas of Barclays; Andy Hubbard of Credit Suisse; Oliver Frankel of Goldman Sachs; Ali Balali of Bank of America; and Biswarup Chatterjee of Citigroup.
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Critics have called these banks the “derivatives dealers club,” and they warn that the club is unlikely to give up ground easily.