NEW YORK ( TheStreet) --The opaque $600 trillion over-the-counter derivatives market begins to come out of the shadows this week as new rules create opportunities and risks for the likes of Goldman Sachs ( GS), JPMorgan Chase ( JPM) CME Group ( CME) and the soon-to-be-merged IntercontinentalExchange ( ICE) and NYSE Euronext ( NYX). Roughly three years after the 2010 Dodd Frank Wall Street Reform and Consumer Protection Act was signed into law, Wall Street megabanks will have to start trading over-the-counter derivatives such as interest rate swaps and credit default swaps through clearinghouses, in a move to minimize the linkages between firms. The idea is to help avoid a repeat of the nightmare chain reaction that followed the collapse of Lehman Brothers in 2008. On March 11, dealers and major market participants -- those who trade over 200 swaps a month -- were compelled to begin clearing so-called "over the counter" trades through clearinghouses. Companies affected by this mandate include Goldman Sachs and JPMorgan. By September, all others such as pension funds and corporations that use OTC markets to hedge their business risks will follow suit. Potential beneficiaries include CME and IntercontinentalExchange, which recently inked a deal to acquire NYSE Euronext that is still awaiting regulatory approvals. Bank of America Merrill Lynch analyst Michael Carrier estimates revenues earned from clearing OTC derivatives trades could grow to up to $750 million annually, or about 8% of the combined revenue of CME Group and the potentially merged IntercontinentalExchange and NYSE Euronext. "
We believe credit default swap and interest rate swap markets represent the largest revenue opportunities for the exchanges/clearing houses (though given some of the FX exemptions, it's likely a smaller opportunity). While it remains an opportunity, it is a different market than futures," writes Carrier, in a March 12 note to clients. He estimates clearing of interest rate swaps could represent up to $600 million in revenue for the market while credit default swaps could represent up to $150 million, with additional earning opportunities from new trading facilities and the need for specialized market data. One risk, however, is that those exchanges are now likely to be considered 'systemically important,' and vulnerable to new regulation, according to Carrier. For Wall Street's largest traders, the move to clearinghouses also poses a mix of risks and benefits, according to Carrier.
Were rules forcing OTC trading into clearinghouses to preempt an increase in electronic trading instead of independently negotiated trades, Carrier notes that Wall Street banks could face further pressure on trading earnings. "
We view clearing alone as a modest headwind," writes the analyst. JPMorgan could see a 4% earnings hit as a result of having to process trades through clearinghouses, however, the move could free up capital for the nation's largest bank by assets. On the other hand, Carrier cites Goldman as being among "a few of the leading dealers" that could "gain a first mover technological advantage," from the switch. The implementation of the new swaps rules is just the beginning of reforms to some of the risky trading environment prior to the financial crisis, as Wall Street and Washington continue to hammer out the so-called Volcker Rule to put limits on how much capital megabanks can speculate on risky trading activities. -- Written by Antoine Gara in New York Follow @AntoineGara