Special Report: In derivatives trade, RIP OTC?

By Huw Jones

LONDON (Reuters) – To get a measure of what financial markets think about plans to make trading in derivatives more uniform and transparent, ask no further than the regulators themselves. Thomas Huertas, a senior UK Financial Services Authority official, said recently that unless the plans to centralize trillions of dollars’ worth of contracts were thought through carefully, it could be a bit like “putting a Chernobyl in the back yard.”

With its echo of Warren Buffett’s description of derivatives themselves as “financial weapons of mass destruction,” Huertas’ choice of language reflects how potent the industry has become, not to mention hard to understand and difficult to tame.

Yet that is just what regulators are trying to do, and they’ve got a fight on their hands.

Big companies regularly use derivatives as a form of insurance to guard against jumps in the price of everything from cocoa to interest rates. An airline will buy jet fuel derivatives so that if prices spike, the contract helps to make up the difference in price, enabling the carrier to budget and plan ahead. If jet fuel prices fall, the loss made on the derivatives contract is canceled out by savings from cheaper refueling bills. It’s the same with barley for beer or aluminum for cans, or any other commodity you can think of.

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