Monday, March 4, 2013

Dodd Frank Act & OTC Swaps

MetaStock SPRS Series - Week 108 - TechniTrader® Stock Discussion for MetaStock Users - Dodd Frank Act & OTC Swaps - March 4, 2013
By: Martha Stokes C.M.T.
What the professionals worry about and discuss in their news feeds is totally different than what the retail side worries about and discusses incessantly in their news. The pros are currently focused on the new regulations being set in place with the Dodd Frank Act. The discussions have gone way beyond whether that is a good or bad law to how to cope with the regulations and what it means for the financial markets’ capital structures, individual professional traders’ profits, and dealers’ profits and risk. Right now, Swaps are up for some major regulation. The OTC Swap market is gargantuan. The outstanding contracts are estimated to be $600 trillion in notional value which is 40 times the US GDP. The market turnover is approximately 2.5 times a year which means there is an estimated $1,800 trillion notional value traded annually. That is a staggering amount. Swaps are a major part of profitability, risk management, hedging, and growth of the financial industry. Pros have many concerns as the OTC Swaps have been mandated to have clearing houses just as stocks and other instruments are cleared, as a means of full transparency and full documentation of the risk inherent in the financial system.

As an example, the international Banks have been holding a vast number of Interest Rate OTC Swaps. This was a hugely profitable trading strategy for them while the Feds suppressed interest rates. But without knowing exactly how many of these Swaps were out there, the risk is high that there may not be sufficient collateral in the event something started to unravel. Another big discussion is whether dealers can still make the huge profits as these OTC markets convert to more traditional and standardized systems. These are the worries of the professional side at this time. Certainly transparency in such a massive market as OTC Swaps is necessary, but margin to cover losses is a key issue.

What you need to worry about as a retail trader are those firms that are vested in Swaps and the risk these changes and mandates will create for those firms. Certainly GS, C, BAC, JPM, and other big banks, dealers, and market makers are going to see major structural changes to their Swaps trading activity and this will have a ripple effect in stocks, options, indexes, ETFs that are associated with financial services, and big banks. The retail side news is telling everyone banks are a great bargain. The Professional side is watching and waiting to see what the OTC Swap regulations truly mean for these industries’ future profitability.

Trade wisely,

Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
MetaStock Partner
©2013 Decisions Unlimited, Inc.

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