AN EVALUATIoN of ACESA’S dERIVATIVES REGULATIoN pRoVISIoNS
t is harder to imagine a more wrongheaded regulatory framework than ACESA’s deriva- tives provisions. It is ironic that, in the aer- math of an election waged and won on a theme of “change,” legislators would cast back to the era of the Charleston and rumble seats for their regulatory model. e regulatory schema of the GFA, and then the CEA, proved unworkable and unduly restrictive in the 1980s and 1990s, and if implemented in the 2000s, would prove so again. Moreover, substantively, the provisions are not economically sensible. I
e complete restructuring of the organization
of derivatives trading presumes that the world’s largest nancial markets—the OTC derivatives markets—are in fact the largest market failures in
nancial history. e advocates of these sweeping
changes have identied, however, no commonly understood source of market failure, such as an externality or public good problem. Moreover, an understanding of the economics of trading makes it clear why multiple trading venues have evolved and thrived.
Potential users of derivatives are heterogeneous. Hedgers have varied risk exposures, as well as dierent risk preferences and nancial objec- tives. Speculators dier, inter alia, in their risk
tolerance, capital, information, and market views. Standardized, one-size-ts-all instruments and trading methods cannot accommodate this het- erogeneity. Customization of contracts results in a more discriminating match between product characteristics and the preferences and needs of users.
Exchanges specialize in the creation of standard products and in the operation of auction mar- kets to trade these products. Design of a product and operation of an auction market entail xed costs. Moreover, a primary advantage of auction markets is that they can oer substantial liquid- ity, but only if the scale of trading is suciently large. Given these xed costs, and the associated economies of scale, it is economical to create and trade a particular product if the demand to trade it is suciently high. It is not economical to cre- ate new products and the capacity to trade them if only a relatively small niche of market partici- pants trades these products.
e parallel development of centralized auc-
tion markets that trade standardized products and bilateral OTC markets that trade custom- ized products permits users to make trade-os based on their preferences. ey can trade stan- dardized products in liquid markets, or they can trade customized products in relatively illiquid ones. For some derivatives traders, liquidity is the
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E f f I C I E N T LY R E G U L AT I N G T h E C A R b o N d E R I VAT I V E S M A R k E T