As a result of OTC clearing reform – Dodd-Frank, EMIR – the cost of OTC deals is clearly going to rise, and spreads and volumes are going to fall. Who can make money in a market like that?

With the cost of eligible collateral pledged to clearing houses rising – due to the shortage of collateral, cash and non-cash – banks will have no choice but to start charging customers a proper price for rental of their balance sheet, for collateral transformation and upgrade. Maybe not from day one in January 2013, because some banks may still be pricing for market share, but soon, surely?

As the market matures, price-cutters will inevitably withdraw from loss making ventures, and the price of OTC deals to the buy-side will inexorably rise to reflect the true cost. Buyers of OTC hedges will surely be more circumspect about the deals they place as a result. There will be fewer deals made, and only for risks really worth hedging – given the higher cost threshold. Volumes will fall.

That might be okay if spreads remain fat. But at the same time as volumes fall, spreads will be squeezed as prices become discoverable and transparent on SEFs. That’s a tough combination.

Is there money to be made?

Yes. But only with volume. And only with uber-STP, no-touching-the-sides, zero-ops infrastructure.

Who can afford that? Not many. Numerous firms will have no choice but to invest in client clearing just to protect the customer franchise. 

Will they make money? Hmmm. What do you think?