tag:theconversation.com,2011:/uk/topics/derivatives-2398/articlesDerivatives – The Conversation2021-04-01T19:03:43Ztag:theconversation.com,2011:article/1582972021-04-01T19:03:43Z2021-04-01T19:03:43ZVital Signs: swaps, options and other derivatives aren’t just for the financial elite<figure><img src="https://images.theconversation.com/files/393045/original/file-20210401-15-5jhw6s.jpg?ixlib=rb-1.1.0&rect=0%2C580%2C4000%2C2083&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Paulus van Dorsten/Shutterstock</span></span></figcaption></figure><p>One of the biggest trends in economics over the past 40 years has been so-called “financialisation” – whereby an increasing proportion of GDP in advanced economies comes from the financial sector. </p>
<p>This has involved the development of ever more sophisticated “financial instruments” such as swaps, options and other derivative securities. </p>
<p>The global mobility of financial capital has also given banks and hedge funds massive piles of money with which to make leveraged bets on everything from stock prices to the fourth derivative of the volatility of South American currencies — which is (I kid you not) a contract on the rate of change on the rate of change on the rate of change in currency value.</p>
<p>As Harvard economists Robin Greenwood and David Scharfstein <a href="https://www.aeaweb.org/articles?id=10.1257/jep.27.2.3">have noted</a>, in 1980 the financial sector accounted for 4.9% of US GDP. By 2007 it was 7.9%. Since 1980, they note, the financial sector’s share of GDP has increased at 13 basis points a year, compared with 7 basis points a year over the 30 years prior.</p>
<h2>The dark side of financialisation</h2>
<p>Financialisation’s dark side is known to anyone who has seen the movie The Big Short.</p>
<p>The financial sector went from being “boring” in the 1970s and early 1980s to being a playground for clever, sometimes unscrupulous traders driven by huge incentives and the prospect of paydays in the tens, or hundreds of millions.</p>
<p>Given some of the ugly and venal behaviours we have seen, it is hardly surprising there has been a huge backlash against big banks and hedge funds. Too often these behaviours have brought the global financial system to the brink.</p>
<p>As far back as 1998 a rinky-dink little hedge fund (backed by two Nobel Prize-winning economists, <a href="https://www.nobelprize.org/prizes/economic-sciences/1997/scholes/biographical/">Myron Scholes</a> and <a href="https://www.nobelprize.org/prizes/economic-sciences/1997/merton/biographical/">Robert Merton</a>, Long-Term Capital Management, believed it had an unbeatable system to play these markets. Instead it turned US$1 billion into US$125 billion of toxic derivatives bets, almost bringing down financial markets around the world. </p>
<p>Then there are the collapses of Bear Stearns and Lehman Brothers due to the subprime mortgage crisis, which precipitated the global financial crisis of 2008.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/lessons-from-the-2008-financial-crisis-for-our-coronavirus-recovery-today-recovery-podcast-series-part-six-142203">Lessons from the 2008 financial crisis for our coronavirus recovery today – Recovery podcast series part six</a>
</strong>
</em>
</p>
<hr>
<h2>The bright side of financialisation</h2>
<p>But it’s not all bad news. A <a href="https://www.aeaweb.org/articles?id=10.1257/mac.20180429&&from=f">new paper</a> by MIT economists Felipe Iachan and Alp Simsek with Plamen Nenov at the Norwegian Business School explores the idea that financial innovation can provide investors, small and large, with more choice, with positive results for their savings decisions and investment returns.</p>
<p>Before the advent of mutual funds, it was very hard (and expensive) for small investors to invest in the stock market. The advent of such funds increased stock-market participation in the US from about 10% of households in the 1950s to more than 50% by the end of the 1990s.</p>
<p>In Australia, effective stock-market participation is now even more pervasive due to our superannuation system, whereby almost anyone who has had a full-time job has stock investments. </p>
<p>What does this mean for the amount of savings, and for asset prices?</p>
<p>You might think that increased portfolio choice would decrease savings — and you’d be in good company. </p>
<p>The traditional literature in financial economics predicts just that. The logic is that people save to protect themselves against risks — such as losing their job because the industry in which they are employed is battered by international competition or technological change. </p>
<p>By investing in stocks, they hedge that risk by exposing themselves to other industries and firms. If the industry in which they work turns down their stock market investments might be going up.</p>
<p>As a result of this more efficient saving, households don’t need to do as much saving as if they were holding piles of cash or government bonds. Because those savings aren’t as diversified. So savings should go down and interest rates should go up, all else equal. </p>
<h2>Contradicting evidence</h2>
<p>But, as the authors of this new paper point out, the evidence is that “while there is a well-known negative trend in saving rates since the 1980s, the trend has been much weaker for participants”. </p>
<blockquote>
<p>Put differently, stock-market participants have increased their saving relative to non-participants since the 1980s. </p>
</blockquote>
<p>And that’s controlling for wealth, so it’s not about how much people have to invest but in what, and how much, they invest.</p>
<p>They go on to offer a framework in which investors who hold different beliefs about asset returns can express those beliefs more effectively when financial innovation provides them with a greater choice of investment products.</p>
<p>This isn’t just a matter of theory — elegant though the authors’ theory is. The empirical evidence suggests this “choice channel” explains two important facts about investment returns in recent years. </p>
<p>First, stock market participants save more than non-participants. Second, “similar households seem to receive more dispersed portfolio returns in recent years”.</p>
<h2>Pros and cons</h2>
<p>There has been plenty of justified criticism of the financial sector in recent years. Risky and unseemly things have been done, hurting regular folk a great deal.</p>
<p>But we shouldn’t forget new and better financial products can also help small-time investors. Perhaps the leading example is index funds that allow them to hold a diversified portfolio of the whole stock market at very low cost — a fee of, say, 0.05% a year, rather than the 1% commonly paid stock pickers for inferior performance.</p>
<p>This is why the option of a low-cost index fund should be at the heart of Australia’s superannuation system.</p><img src="https://counter.theconversation.com/content/158297/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Holden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The dark side of ‘financialisation’ is well-known. But it’s not all bad news.Richard Holden, Professor of Economics, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1477752020-10-09T13:56:25Z2020-10-09T13:56:25ZBitcoin: the UK and US are clamping down on crypto trading – here’s why it’s not yet a big deal<figure><img src="https://images.theconversation.com/files/362649/original/file-20201009-19-1qzu5ko.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Where there's a bit there's a writ. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/barrier-gate-bitcoin-prohibition-sign-cryptocurrency-1012638586">Novikov Aleksey </a></span></figcaption></figure><p>The sale and promotion of derivatives of bitcoin and other cryptocurrencies to amateur investors is <a href="https://www.fca.org.uk/news/press-releases/fca-bans-sale-crypto-derivatives-retail-consumers">being banned</a> in the UK by the financial regulator, the Financial Conduct Authority (FCA). It is a further blow to the burgeoning cryptocurrency market, coming days after the US authorities <a href="https://www.nytimes.com/2020/10/01/technology/bitmex-bitcoin-criminal-charges.html">indicted the owners</a> of leading crypto derivatives exchange BitMex for operating without being US-registered and allegedly failing to follow anti-money-laundering rules.</p>
<p>In view of <a href="https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/3rd-global-cryptoasset-benchmarking-study/">recent findings</a> from the University of Cambridge that most firms involved in crypto investments are still operating without a licence, other operators are potentially vulnerable to indictments too. </p>
<p>It all sounds like bad news for anyone hoping that more investors will put money into cryptocurrencies. But on a closer inspection, I’m not so sure. </p>
<h2>Drops and oceans?</h2>
<p>The FCA is preventing retail investors from buying and selling the likes of cryptocurrency futures and options, which people often use as a way of hedging their bets on an underlying asset. For example, you might buy an option to sell a certain number of bitcoin at today’s price if the price falls by 10%, giving you an insurance policy in case the market moves against you. </p>
<p>The <a href="https://www.fca.org.uk/news/press-releases/fca-bans-sale-crypto-derivatives-retail-consumers">FCA said</a> it was introducing the ban from January 6 because amateur investors were at risk of “sudden and unexpected losses”. The reasoning is that these people often don’t understand the market, there is lots of “market abuse and financial crime” in the sector, cryptocurrencies are very volatile and they are hard to value. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/362650/original/file-20201009-23-dv5vdz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="FCA web page" src="https://images.theconversation.com/files/362650/original/file-20201009-23-dv5vdz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/362650/original/file-20201009-23-dv5vdz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/362650/original/file-20201009-23-dv5vdz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/362650/original/file-20201009-23-dv5vdz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/362650/original/file-20201009-23-dv5vdz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/362650/original/file-20201009-23-dv5vdz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/362650/original/file-20201009-23-dv5vdz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The UK regulator is trying to protect investors.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/homepage-fca-org-website-on-display-1624573054">Mehaniq</a></span>
</figcaption>
</figure>
<p>To stress, the ban is not being extended to professional traders or institutional firms like hedge funds, which have typically been allowed access to riskier financial products than the general population. It is about protecting <a href="https://www.fca.org.uk/publication/research/research-note-cryptoasset-consumer-research-2020.pdf">people who</a> might have been drawn to bitcoin thinking “it may be the currency of the future”, having “heard sensational news coverage about the rise and fall”. There are any number of splashy trading sites offering them quick and easy entry into this world, and YouTube influencers who <a href="https://www.youtube.com/watch?v=2AmpMMZJSws">enthusiastically encourage them</a> to try complex trading. </p>
<p>Some 1.9 million people – around 4% of the adult population – own cryptocurrencies <a href="https://www.fca.org.uk/publication/research/research-note-cryptoasset-consumer-research-2020.pdf">in the UK</a>. Three-quarters have holdings worth less than £1,000 and would certainly qualify as retail investors. We don’t know what proportion of UK investors use crypto derivatives, but we do know that the worldwide trade in these financial products was <a href="https://www.nasdaq.com/articles/how-to-leverage-the-expected-2020-crypto-derivatives-trading-boom-2020-03-03">nearly a</a> fifth of the total <a href="https://medium.com/@TokenInsight/2019-cryptocurrency-spot-exchange-industry-annual-report-d022d1c29e3f#:%7E:text=first%20to%20respond.-,%2413.8%20Trillion%20Annual%20Spot%20Exchanges%20Trading%20Volume%20%E2%80%94%202019%20Cryptocurrency,Exchange%20Industry%20Annual%20Report%20Shows">crypto market</a> in 2019 (and <a href="https://internationalbanker.com/brokerage/crypto-derivatives-are-on-the-rise/">has been</a> growing rapidly in 2020).</p>
<p>Yet retail investors are probably not the main users of derivatives. Trading site <a href="https://www.coindesk.com/retail-investors-arent-interested-in-crypto-derivatives-says-etoro-executive">eToro said</a> earlier this year that maybe only a tenth of their retail investor spend was on this segment. And <a href="https://www.fca.org.uk/publication/research/research-note-cryptoasset-consumer-research-2020.pdf">with most</a> of the UK contingent using non-UK based exchanges, it’s easy enough to avoid FCA jurisdiction. The FCA says the ban could reduce annual losses and fees to investors by between £19 million and £101 million.</p>
<p>The ban also doesn’t make much difference at a worldwide level. The UK crypto market is small beer compared to global cryptocurrency holdings, which <a href="https://coinmarketcap.com/">are worth US$335 billion</a> (£258 billion). You would not therefore have expected the FCA ban to have a material detrimental impact on the price of bitcoin or leading alternative coins like ethereum, and sure enough, <a href="https://www.coingecko.com/en">it didn’t</a>. In fact, it was widely expected by industry observers and had arguably already been priced in. </p>
<h2>Volatility and excessive risk</h2>
<p>The fact that the price of bitcoin is very volatile has historically been the scourge of this sector, with many specialists <a href="https://www.theblockcrypto.com/post/54060/deutsche-bank-says-bitcoin-is-too-volatile-to-be-a-reliable-store-of-value#:%7E:text=Bitcoin's%20price%20fluctuations%20do%20not,financial%20services%20giant%20Deutsche%20Bank.&text=Particularly%20for%20bitcoin%2C%20the%20world's,%E2%80%9Creliable%E2%80%9D%20store%20of%20value">repeatedly saying</a> that this prevents it from serving as a store of value and becoming a functional currency. You could argue that banning some derivatives trading has the potential to reduce this volatility. </p>
<p>When people buy derivatives, they can be highly levered, meaning that they are borrowing to increase the size of their trade to make greater potential gains (or losses). Many exchanges, typically in Asia, allow investors to borrow 15 times the size of the trade, while some offer over <a href="https://www.deribit.com/">100 times leverage</a>. </p>
<p>When trades are leveraged, investors enter and exit the market more quickly, since their loss or gain is multiplied by the proportion they have borrowed. It’s this effect on the market <a href="https://www.tandfonline.com/doi/abs/10.1080/14697688.2012.674301">that increases</a> price volatility. Yet bitcoin has lately been trading at an <a href="https://www.buybitcoinworldwide.com/volatility-index/">all-time low</a> for volatility, so the ban may not achieve much in this respect.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/362653/original/file-20201009-13-1f32jj0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Rollercoaster on a stock market graph" src="https://images.theconversation.com/files/362653/original/file-20201009-13-1f32jj0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/362653/original/file-20201009-13-1f32jj0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=373&fit=crop&dpr=1 600w, https://images.theconversation.com/files/362653/original/file-20201009-13-1f32jj0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=373&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/362653/original/file-20201009-13-1f32jj0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=373&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/362653/original/file-20201009-13-1f32jj0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=469&fit=crop&dpr=1 754w, https://images.theconversation.com/files/362653/original/file-20201009-13-1f32jj0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=469&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/362653/original/file-20201009-13-1f32jj0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=469&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">A day in the life of bitcoin (until recently).</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/roller-coaster-graph-recovery-386527768">Studio77 FX Vector</a></span>
</figcaption>
</figure>
<p>None of this is to say that the ban is meaningless. Derivatives make markets more efficient by allowing investors to hedge their bets, so even a partial ban in one major country has to be seen as a step backwards for cryptocurrencies. There is also a bigger danger for the industry that other leading global financial regulators such as the SEC in the US and BaFin in Germany may follow suit.</p>
<p>This damage could be greatly aggravated if the US or other authorities were to indict other unregistered exchanges like BitMex. That could cause a liquidity crisis as investors withdrew their money en masse. Again, we will have to wait and see what happens. BitMex <a href="https://www.coindesk.com/bitmex-says-its-business-as-usual-despite-30-drop-in-bitcoin-balance-after-cftc-doj-action">has said</a> that around 30% of customer funds have been withdrawn since the US issued charges, but insists it is open for “business as usual”.</p>
<p>But as far as the UK ban is concerned, I would argue on balance that curtailing excessive risk-taking by amateur traders in a sector where trading vanilla cryptocurrencies is risky enough seems logical. I have met many “retail investors” in crypto whose depth of knowledge is refreshing, far exceeding that of financial institutions, but there will certainly be others who don’t understand their risks. </p>
<p>To end on a positive note, part of the <a href="https://www.fca.org.uk/news/press-releases/fca-bans-sale-crypto-derivatives-retail-consumers">FCA’s reasoning</a> for the ban was that there was “no reliable basis” for valuing cryptocurrencies. It did not say there was no value in cryptocurrencies. That is a noticeable shift from what regulators might have said in the past, and is a sign that bitcoin is becoming more widely accepted.</p><img src="https://counter.theconversation.com/content/147775/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Gavin Brown is a Non-Executive Director and Co-founder at Winterbar Associates Limited, a start-up digital assets fund which has yet to launch. It would not benefit directly from this article but does have an interest in digital asset investments such as Bitcoin which leverage blockchain technology. </span></em></p>In quick succession, UK has banned certain crypto derivatives trading and the owners of leading exchange BitMex have been indicted on criminal charges.Gavin Brown, Associate Professor in Financial Technology, University of LiverpoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/868522017-11-06T19:20:21Z2017-11-06T19:20:21ZWith a new futures market, Bitcoin is going mainstream<figure><img src="https://images.theconversation.com/files/193148/original/file-20171103-26426-1f1i7w4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A Bitcoin futures market will take some of the risk out of the currency. </span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>The Chicago Mercantile Exchange <a href="http://www.cmegroup.com/media-room/press-releases/2017/10/31/cme_group_announceslaunchofbitcoinfutures.html/">will soon begin trading</a> Bitcoin derivatives (futures contracts), signalling the cryptocurrency is now a mainstream asset class. Bitcoin has had limited use in the mainstream economy in part because the volatility of its price. The value of the currency might go up or down significantly between the time a deal is struck and delivery. </p>
<p>The introduction of Bitcoin futures contracts will allow investors to manage this risk, and make it safer to hold and trade in Bitcoin. This will make the cryptocurrency more accessible to individuals and businesses, and encourage developers to build more products and services on top of the technology.</p>
<p><iframe id="8Sbjf" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/8Sbjf/1/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>Futures and other derivatives are contracts between two parties to fix the price of an underlying asset (currencies, shares, commodities etc.) over a period of time or for a future transaction. The buyer of these contracts commits to purchase the underlying asset at a set price and at a certain date, and the seller commits to sell. </p>
<p>There are two main uses for these contracts. First, to reduce price risk by freezing future prices. The second use is speculation. For instance, a speculator would commit to buy a commodity/share/currency at a certain time, hoping that the market price at the time of delivery is higher than the price set in the contract. </p>
<p>Airlines commonly buy long term oil future contracts to hedge against the potential increase in fuel price, or to <a href="https://www.cnbc.com/2016/04/06/airline-hedges-fuel-rally-in-later-dated-oil-prices.html">take advantage of what they believe to be a low price</a>. </p>
<p>Similarly, future contracts will enable traders to lock in the value of Bitcoin for a defined period of time. This effectively removes the risk associated with fluctuation in value. In addition, since these contracts will be traded on the Chicago Mercantile Exchange, the exchange effectively guarantees that both buyers and sellers will abide by the agreement.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/price-hikes-in-ether-and-bitcoin-arent-the-signs-of-a-bubble-79350">Price hikes in Ether and Bitcoin aren't the signs of a bubble</a>
</strong>
</em>
</p>
<hr>
<p>In 2010, one Bitcoin was worth less than <a href="https://en.wikipedia.org/wiki/History_of_bitcoin">one hundredth of an Australian cent</a>. As of Monday the 6th of November, the price is near <a href="https://bravenewcoin.com/bitcoin?mkt=AUD#Exchanges">A$10,000</a>. </p>
<p>The market capitalisation of Bitcoin is now well over A$160 billion, which is larger than the GDP of most small countries. As the price of Bitcoin has grown, so too have <a href="https://www.quandl.com/data/BCHAIN-Blockchain">transaction volumes</a>, showing an increasing use of the cryptocurrency. </p>
<p>As a result, Bitcoin is starting to look like a credible investment in any respectable financial portfolio.</p>
<p>Although, this is not the first futures contract for cryptocurrency. Futures contracts already exist for both <a href="https://www.bitmex.com/app/seriesGuide/ETH">Ethereum</a> and <a href="https://www.bitmex.com/app/seriesGuide/XMR">Monero</a>. </p>
<p>But the Chicago Mercantile Exchange’s futures contract is significant as the <a href="http://www.cmegroup.com/">CME group</a> manages not only the Chicago Mercantile Exchange, but also the Chicago Board of Trade and New York Mercantile Exchange and Commodity Exchange. Combined, these exchanges represent the largest derivative market in the world. </p>
<p>The decision to issue futures contracts on Bitcoin rather than another derivative is also significant. So far Bitcoin derivatives have <a href="https://www.bitmex.com/app/swapsGuide">mainly been swap agreements</a>. A swap is a commonly used financial tool where two parties agree to swap financial instruments, such as interest or currencies. The key point is that the two parties, the buyer and seller, make a deal directly with each other. </p>
<p>As a swap agreement is not done through an exchange, the risk of a party not delivering on the agreement can be quite high. If one party decides to opt out, the agreement has to be terminated. This leaves the other party exposed. </p>
<p>Futures contracts eliminate this “counterparty” risk, as the exchange clears the transaction and guarantees delivery. And unlike swaps, futures contracts are standardised (in term of size, how much is going to be traded, and maturity date etc.). This means futures contracts can be traded at any time until maturity, making them very liquid and accessible.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/taking-bitcoin-to-the-stockmarket-wont-do-much-for-its-risky-image-68474">Taking Bitcoin to the stockmarket won't do much for its risky image</a>
</strong>
</em>
</p>
<hr>
<p>The lack of a futures market in Bitcoin was a significant barrier to it becoming a mainstream asset class. You can buy and sell forward contracts on the Fijian dollar, for instance, meaning that institutional funds anywhere in the world can hold Fijian dollars in their portfolio and manage the risks of that asset.</p>
<p>But they cannot yet do that with Bitcoin. Until now, there has been no way to offload the risks associated with fluctuating prices. An investor could always hold the cryptocurrency, but they would do so fully exposed to price volatility.</p>
<p>The introduction of Bitcoin futures contracts will allow traders to hedge against this volatility and eliminate the currency risk. This will make Bitcoin more attractive for both individuals and corporations.</p>
<p>As crypto-assets become a mainstream investment class, other products emerge around them (such as <a href="https://www.sec.gov/Archives/edgar/data/1137360/000093041317002900/c89143_485apos.htm">exchange traded funds</a>). It will also have a similar effect to that of mainstreaming share ownership - enabling a much larger fraction of the population to diversify their asset portfolios and income streams.</p>
<p>This will unlock some of the value currently being built on cryptocurrencies and blockchain technology - new products and services - that are currently only accessible to a relatively small number of the early enthusiasts and those helping build the technology.</p>
<p>The increased flow of investment funds into Bitcoin will likely push prices up further, but it will also incentivise more work to build products and services on the technology. Bitcoin just went mainstream.</p><img src="https://counter.theconversation.com/content/86852/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jason Potts receives funding from the Australian Research Council. Jason Potts is Director of the Blockchain Innovation Hub at RMIT University. </span></em></p><p class="fine-print"><em><span>Marie-Anne Cam receives funding from the Australian Research Centre for Financial Studies (ACFS). Marie-Anne is the Chair of the RMIT Trading Facility Committee. </span></em></p>The introduction of Bitcoin futures contracts will remove a lot of the financial risk associated with the cryptocurrency.Jason Potts, Professor of Economics, RMIT UniversityMarie-Anne Cam, Senior Lecturer in Finance, RMIT UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/579982016-04-21T20:41:02Z2016-04-21T20:41:02ZWhy the rand punches above the weight of South Africa’s economy<figure><img src="https://images.theconversation.com/files/119478/original/image-20160420-25595-1edcj9k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The South African rand is the 18th most traded currency in the world. </span> <span class="attribution"><span class="source">Reuters/Siphiwe Sibeko</span></span></figcaption></figure><p>Is the size of the South African economy out of sync with the ranking of the rand as the 18th most traded currency in the world?</p>
<p>The South African economy is the 33rd biggest in the world, with a <a href="http://databank.worldbank.org/data/download/GDP.pdf">gross domestic product</a> of US$350 billion in 2014. But its currency, the South African rand (ZAR), is <a href="http://www.bis.org/publ/rpfx13fx.pdf">ranked 18th</a> when the percentage shares of the average daily turnover of the global foreign exchange market are considered. </p>
<p>The South African rand has recently experienced an unprecedented level of volatility – more so than most, if not all, emerging-market currencies. But a greater part of the pain has been self-inflicted.</p>
<p>The low economic growth outcomes in the recent past, as well as the poor growth outlook and domestic political risk issues have all <a href="http://www.bdlive.co.za/economy/2016/03/18/bank-points-to-political-uncertainty-fuelling-rand-volatility">contributed to</a> putting the local currency on the back foot. An example of this played out in South Africa in December 2015, when the country’s finance minister <a href="http://www.timeslive.co.za/politics/2015/12/10/COMMENT-Nene-fired---Zumas-capture-of-the-state-is-now-complete">was abruptly fired</a> and replaced with an unknown backbencher. Investors lost confidence in the running of the economy, with terrible consequences for the rand, which reached a new low of more than R16/US$. </p>
<h2>Size of economy vs currency trades</h2>
<p>But this recent volatility can’t be blamed on the fact that the rand punches above its weight in the foreign exchange market. Other reasons account for this.</p>
<p>South Africa is not alone. There are many other small economies in the world whose currencies have bigger shares in the global foreign exchange market.</p>
<p>For example, the Swiss franc is the sixth <a href="http://www.bis.org/publ/rpfx13fx.pdf">most important foreign exchange market</a> in the world, but the country is <a href="http://databank.worldbank.org/data/download/GDP.pdf">ranked as the 20th</a> biggest economy. New Zealand is ranked as the <a href="http://databank.worldbank.org/data/download/GDP.pdf">53rd biggest economy</a>, but the New Zealand dollar is the tenth <a href="http://www.bis.org/publ/rpfx13fx.pdf">biggest foreign exchange market</a>.</p>
<p>On the reverse side, there are a number of countries with big economies whose currencies are traded very little. This is because they don’t have a well-developed financial market. South Africa’s <a href="http://globalsherpa.org/bric-countries-brics/">BRICS partners</a> Brazil and India have much bigger economies than South Africa, but their foreign exchange markets are smaller.</p>
<p>The US and Japan, the first and third biggest economies in the world, also have well-developed financial markets. It is therefore no wonder that the US dollar and the Japanese yen are the first and third most traded currencies in the world.</p>
<p>The Chinese yuan occupies <a href="http://www.bis.org/publ/rpfx13fx.pdf">ninth position</a> in the ranking of traded currencies, even though it is the second biggest economy in the world. This is due to the fact that its financial markets are relatively underdeveloped.</p>
<p>This shows that the size of an economy has no role in the tradeability of its currency.</p>
<h2>ZAR foreign exchange market size</h2>
<p>The ZAR foreign exchange market, like that of any other tradeable asset, is underpinned by demand and supply. These determine its market size.</p>
<p>There are a number of critical players on both sides. They include:</p>
<ul>
<li><p>Individuals and institutions that plan to buy South African assets – real and financial. Real assets include residential and non-residential properties. Financial assets are made up of bonds, stocks, derivatives and other financial instruments. On the supply side are those who plan to sell these assets.</p></li>
<li><p>The export demand of South African goods and services is also a major source of demand for the currency. In the same way, the supply side is driven by exporters of South African goods and services </p></li>
<li><p>Currency speculators. Speculators of the currency buy and sell and sometimes hold the currency for a while to make a return from favourable fluctuations in its value. Speculators are also a source of supply. </p></li>
</ul>
<p>Who is doing the buying and selling? A host of players are active in the foreign exchange market of the rand. These include: commercial and investment banks, central banks, securities houses, asset and fund managers, companies and institutional investors such as pension funds.</p>
<h2>Benefits and risks</h2>
<p>The interest in South Africa’s currency in the global foreign exchange market is a reflection of how the domestic economy is plugged into the world economy, particularly the developed world. This needs to be cherished. </p>
<p>This connectivity is facilitated by a financial system that is well regulated. In fact, it outperforms a great many other developed countries. For example, for four consecutive years the country was ranked number one in the world when it comes to the <a href="https://www.jse.co.za/news/wef-global-competitiveness-report-2013-2014-south-africa-ranks-first-in-regulation-of-securities-exchanges">regulation of securities exchanges</a>.</p>
<p>The benefit of being connected to the international financial market is that South Africa’s market is exposed to a larger number of participants. This contributes immensely to the liquidity of domestic real asset and financial asset markets. </p>
<p><a href="http://www.jstor.org/stable/2961967?seq=1#page_scan_tab_contents">Classical economic theory</a> suggests that high liquidity results in trades being priced correctly. This doesn’t happen in an illiquid market with a small number of buyers and sellers. </p>
<h2>The danger posed by speculators</h2>
<p>Speculators pose the biggest risk to a currency. Because the rand is traded in all major foreign exchange markets such as the UK, US, Japan, Singapore and Hong Kong, speculators can present a danger to its pricing. </p>
<p>But the risk of an attack by speculators is minimal if the South African Reserve Bank is seen to be pursuing a sensible exchange rate policy. For instance, if the South African Reserve Bank decides to intervene in the rand foreign exchange market with the intention of managing the currency’s exchange rate it may open up the currency for speculative attacks.</p>
<p>A classic example is the famous “Black Wednesday” episode, when speculators <a href="http://www.investopedia.com/ask/answers/08/george-soros-bank-of-england.asp">broke the British pound</a> on September 16 1992. The British government got its fingers badly burnt in an attempt to support the pound. One speculator, <a href="http://moneymorning.com/2015/06/10/how-did-george-soros-break-the-bank-of-england/">George Soros</a>, is reported to have walked away with $1 billion in a single day from betting against the Bank of England. </p>
<p>Its lesson shouldn’t be lost on anyone. </p>
<p>In fact, the hands of the South African Reserve Bank are tied as far as the rand’s foreign exchange rate is concerned. Even if it wanted to, it couldn’t intervene in any meaningful way to influence the direction of the currency’s foreign exchange rate. This is because it doesn’t have the resources: the foreign exchange market is massive relative to the foreign exchange reserves of the country.</p>
<p>Just look at the numbers. The bank’s gross <a href="https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/7244/GoldFXReserves_March2016.pdf">official gold and foreign exchange reserves</a> are estimated at $47 billion. Given that the value of trade in the rand alone is more than $60 billion in a typical day, it would be foolhardy to imagine that the country’s foreign exchange reserves can be used to prop up the currency’s exchange rate. </p>
<p>That’s not to say that nothing can be done. Undue volatility can be managed. The government and its National Treasury, which oversees the country’s economy, have a role to play. They can make sure that economic policies are sound and stable, and that investor confidence in the country is maintained. The government can also make sure that the rule of law is upheld.</p><img src="https://counter.theconversation.com/content/57998/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Matthew Kofi Ocran receives funding from NRF. </span></em></p>How is it possible that an African country whose currency is one of the top 20 most traded in the world only has the 33rd biggest economy?Matthew Kofi Ocran, Professor of Economics, University of the Western CapeLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/358872015-01-07T11:11:36Z2015-01-07T11:11:36ZBogeyman of credit crisis needs reform to align risks and responsibilities in CDS market<figure><img src="https://images.theconversation.com/files/68324/original/image-20150106-18616-ien6ba.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Caesars Entertainment argues the credit default swap market is giving at least one holder of its debt a perverse incentive to seek its default. </span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>In 2009, US trucking company YRC Worldwide faced ruin as it struggled to restructure its debt. With tens of thousands of jobs at stake, the Teamsters union, led by James Hoffa, <a href="http://teamster.org/content/hoffa-teamsters-call-regulators-investigate-questionable-insurance-promotion-yrcw-bonds">accused some YRC bondholders</a> of sabotaging restructuring negotiations by purchasing credit default swaps (CDS) on their debt. </p>
<p>Much like an insurance policy, these CDS would pay out if YRC filed for bankruptcy and ensure bondholders that bought the protection got 100 cents on the dollar. Unfortunately for YRC, this meant that these lenders had more to gain if YRC went into bankruptcy than if it survived by restructuring, diminishing their interest in coming to the table and reaching a deal. </p>
<p>This confrontation plays out regularly on Main Street, particularly for riskier borrowers. Creditors want to protect themselves from company defaults by using CDS. But when they do, <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1084075">they can lose interest</a> in monitoring the company or in its continuation as a going concern. In the worst case, lenders might be tempted to push viable but distressed companies towards bankruptcy to trigger a payout on the CDS. If this happens, they can expect to receive 100 cents on the dollar rather than face the large write-offs common to most restructurings. Their fellow bondholders and other creditors such as banks and pension funds who don’t have protection, however, may get just pennies on the dollar. </p>
<p>In a <a href="http://www.investopedia.com/articles/optioninvestor/08/cds.asp">credit default swap transaction</a>, a debtholder or “buyer” of protection agrees to pay an ongoing fee to a “seller” in exchange for assuming the risk that a bond or loan might default. If that happens, the seller pays the buyer to ensure the latter gets the face value of the debt. </p>
<p>CDS have been blamed for causing problems in a slew of restructurings, including Six Flags, Harrah’s Entertainment and General Motors, among others. Caesars Entertainment, the struggling gaming company, for example, <a href="http://www.businessweek.com/articles/2014-12-23/a-bitter-fight-for-caesars-assets">has been negotiating</a> with its creditors to restructure its US$25.5 billion in debt. Caesars accuses one of them, Elliott Management, of buying “significant” CDS protection with the ulterior motive of pushing the company toward a default and triggering repayment on the CDS. </p>
<h2>Widespread welfare costs</h2>
<p>Such strategies can create widespread welfare costs. Lenders play an essential role in ensuring that borrowers use credit productively to grow themselves and the economy. When lenders lose interest in performing this role, borrowers can become reckless in how they manage money. Worse, when lenders push viable companies towards bankruptcy, potentially profitable enterprises can disappear, destroying jobs and the communities they nourish in the process. </p>
<p>These strategies also tarnish the perception of the instruments, already greatly harmed by their role in the 2008 financial crisis. CDS serve an important function of helping lenders hedge their risks, lowering credit costs for Main Street companies. With attention on the negative effects of CDS, it becomes easy to overlook the considerable benefits they bring to the efficient allocation of credit in the economy. </p>
<p>A solution to this problem, however, lies within the CDS market itself. Enter CDS protection sellers. Just as lenders eliminate risk by using CDS, so credit protection sellers assume it. The protection seller pays out on CDS when a borrower defaults. Protection sellers have real skin in the game and, with this, the incentive to monitor borrowers and prevent them from going bust needlessly. </p>
<p>So why don’t they? In short, they do not have the lender’s <a href="http://www.uclalawreview.org/pdf/57-1-3.pdf">host of legal rights</a> to monitor a borrower and to participate in a restructuring. While lenders hold these rights toward the borrower but do not bear the corresponding economic risk when they buy protection, it is the other way around for sellers, with all the risk but none of the rights. </p>
<h2>Of rights and risks</h2>
<p>These rights – common to loan contracts – have real value to those bearing the economic risk of a debt. Monitoring a borrower allows a bank or other lender to keep tabs on its financial solvency and changes in its risk profile, promoting discipline in terms of who gets credit and how it is priced. And the right to participate in a restructuring safeguards economic value, salvaging investments and ensuring that companies that can survive are able to do so. </p>
<p>These legal rights go to waste when lenders lose interest in using them. In the Caesars example, the sellers of CDS protection – who the risk of paying out if the company defaults – are not allowed to participate in negotiations, though they have the most to lose. </p>
<p>This needs to change. Just as credit default swaps allow lenders and protection sellers to trade over who will bear the economic risk of a debt, we need a regulated, transparent market that allows protection sellers to bargain for and trade the basic legal rights that regulate that exposure, so-called creditor control rights. </p>
<p>By gaining the ability to exercise these rights, protection sellers can scrutinize how lenders are monitoring borrowers and intervene if they fail to do so. A market for creditor control rights would help counter the tendency towards lender misbehavior and disinterest that CDS can create. </p>
<h2>Incentives to cooperate</h2>
<p>This market may appear counter-intuitive. The interests of lenders and protection sellers seem to be in conflict: the former wants the payout, the latter does not want to provide it. But this is not true. Lenders and protection sellers have many incentives to cooperate. First, not all CDS-protected lenders want to see their borrowers fail. Strong borrowers represent a lucrative source of future business. Misbehaving lenders can also see their reputations damaged by accusations of opportunism towards borrowers. </p>
<p>In YRC’s case, Hoffa’s campaign against bondholders prompted calls for protests outside offices of hedge funds and letters to the Securities and Exchange Commission. The creditors soon relented, and <a href="http://www.wsj.com/articles/SB10001424052748704350304574638750418217422">YRC’s restructuring moved forward</a>. </p>
<p>Secondly, a reputational bruising can be costly in other ways. Lenders that behave badly may be charged more for CDS protection in the future, reducing the gains of forcing payouts.</p>
<p>Cooperation makes sense. Protection sellers assume some of the burdens of monitoring and researching underlying borrowers, saving lenders time and money. Protection sellers may also offer credit protection to lenders at lower cost, where payouts occur only when default is inevitable. With stronger legal rights, protection sellers can manage their own risks better and participate meaningfully in overseeing credit.</p>
<p>A market for creditor control rights is not a perfect solution. After all, protection sellers might misbehave, making regulation and transparency necessary to prevent abuses towards Main Street borrowers. Still, a solution is needed. CDS are not going away anytime soon. This proposal, however, tackles a major problem in today’s credit markets: the disconnect between those who hold the economic risk of debt and those best motivated to manage it.</p><img src="https://counter.theconversation.com/content/35887/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Yesha Yadav does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>In 2009, US trucking company YRC Worldwide faced ruin as it struggled to restructure its debt. With tens of thousands of jobs at stake, the Teamsters union, led by James Hoffa, accused some YRC bondholders…Yesha Yadav, Associate Professor of Law , Vanderbilt UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/336132014-11-11T10:37:51Z2014-11-11T10:37:51ZFinancial speculation: the good, the bad and the parasitic<figure><img src="https://images.theconversation.com/files/63494/original/wnbmpgg8-1414977257.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Trading floors like this one -- at the old American Stock Exchange in the 1980s -- are at the heart of capitalism and financial speculation. </span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/21734563@N04/3036628966">David Foster/Flickr via CC BY-ND</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span></figcaption></figure><p>The word “speculation” carries a connotation of negativity. And it’s probably fair to say that pretty much every financial crisis since the tulip mania of the 1630s can be <a href="http://www.amazon.com/Manias-Panics-Crashes-Financial-Investment/dp/0471467146">attributed</a> to some sort of mass speculation. There is no question that speculation caused the financial crisis of 2008, first in housing, and then in <a href="http://www.e-elgar.co.uk/bookentry_main.lasso?id=14015">derivative securities</a>. Recent reports on the multiple advantages enjoyed by high-speed traders again brings speculation to the fore and, with it, the <a href="http://online.wsj.com/articles/fast-traders-are-getting-data-from-sec-seconds-early-1414539997?KEYWORDS=high+speed+trading+and+SEC">question</a> of whether it is good, bad or indifferent for the economy. </p>
<p>But first, what does “speculation” really mean? As frequently as it’s used, the term is equally misunderstood. We don’t really define it. Rather, it is one of those things that we know when we see. In order to evaluate speculation, we must first understand what we mean by it.</p>
<p>The definition of speculation has shifted over time, at least with respect to financial markets. At the end of the 19th century, speculation generally meant investing in companies for which you had little or no information. Within a decade, the more common usage was investing in securities where dividends were uncertain. This meant common and, to some extent, preferred stock. Since all dividends are discretionary, all forms of stock were considered speculative. And dividends were <a href="http://online.wsj.com/articles/fast-traders-are-getting-data-from-sec-seconds-early-1414539997?KEYWORDS=high+speed+trading+and+SEC">important</a> because it was to get those – not capital gains – that people bought stock.</p>
<h2>Speculation’s existential crisis</h2>
<p>Matters changed starting in the 1960s. The move from dividends to capital gains had begun in earnest. Speculation now meant investing in the hope of capital appreciation – that is, selling to somebody for a higher price than you paid. Economists writing in the new field of finance claimed that speculation didn’t really exist because markets efficiently priced securities at their anticipated earnings discounted to their present value. This meant that a share of stock was worth what you paid for it. That was investing, not speculating. Cold hard realities have <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1655739">brought this belief</a> into serious question. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/63560/original/hpx7yzk7-1415032260.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/63560/original/hpx7yzk7-1415032260.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/63560/original/hpx7yzk7-1415032260.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=450&fit=crop&dpr=1 600w, https://images.theconversation.com/files/63560/original/hpx7yzk7-1415032260.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=450&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/63560/original/hpx7yzk7-1415032260.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=450&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/63560/original/hpx7yzk7-1415032260.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=566&fit=crop&dpr=1 754w, https://images.theconversation.com/files/63560/original/hpx7yzk7-1415032260.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=566&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/63560/original/hpx7yzk7-1415032260.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=566&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">The tulip mania in the Netherlands in the 1600s is often considered this first recorded speculative bubble. The price of tulip bulbs surged in value then suddenly collapsed.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/veridiano3/13566892413/in/photolist-mERSsa-7D49v3-mERLUg-dZiAtQ-dZcTxk-dZcUK6-dZiB5U-dZiAy9-dZiBBN-dZcT1i-dZcTYi-dZiACY-dZcSSt-dZizUU-dZiAMU-dZcUat-dZcTV6-dZcSVD-dZcT6K-dZizZm-6iXYMA-857Mqk-4HXG55-GVuQb-F7WDV-mERHdZ-HiNRD-mERcvH-7GQhAX-7GUecA-7GUcgU-2sunmR-7GQhcv-7GQi4B-nJvuNC-FbtEe-mESJYG-HiNRr-7vjLb3-egQP1z-ec7yDM-huDz49-9DfZ2m-9N1sKR-ctzfCJ-9yASWX-gmKTRz-gmMFuK-ePyTra-a9L5">Riccardo Palazzani/Flickr via CC BY-NC-SA</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-sa/4.0/">CC BY-NC-SA</a></span>
</figcaption>
</figure>
<p>There is less doubt about the speculative nature of derivative securities that began to develop in the 1990s and exploded at the turn of the 21st century. Those “claims on claims” (or, in Warren Buffett’s felicitous phrase, “financial weapons of mass destruction”) split up the <a href="http://krugman.blogs.nytimes.com/2010/04/18/six-doctrines-in-search-of-a-policy-regime/">underlying financial assets</a> into ever smaller pieces. </p>
<p>Think of the shape of a tornado. The productive asset – the asset that generated the revenue to pay the claims – was a point at the bottom. As claims proliferated from that point up, they expanded higher and higher, wider and wider, far beyond the capacity of the energy at the bottom – the earnings – to sustain it. When investors at the top woke up and realized this, they started massive selloffs – and the whole structure came crashing down. Another way of looking at this is as a Ponzi scheme. It carries the patina of investment legitimacy because, unlike a classic Ponzi scheme, there is <em>some</em> source of earnings. But those earnings are so inadequate to support the securities superstructure that a Ponzi scheme is an appropriate metaphor.</p>
<p>Based on history and contemporary usage, I would define as “speculative” assets that have little or no identifiable financial substance, the returns from which are expected to come from its sale at a higher price to somebody else. The logical conclusion based on this definition is that speculation is never good, at least in the sense that it never contributes to the productive economy. The principle negative economic effect of speculation is to divert resources away from production and into the speculative casino. As long as it’s not excessive, it isn’t all that bad. After all, we allow gambling. Where it becomes bad is when it causes damage to the rest of the economy. And that occurs when speculation becomes parasitic on the productive economy.</p>
<h2>An economic parasite</h2>
<p>Here are a few examples of that happening. Stock bubbles are speculative. It is unlikely the underlying corporations could earn anywhere near enough money to justify prices in any reasonable time frame. That makes them speculative. Stockholders, however, expect management to sustain or increase prices. This <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1557730">puts pressure</a> on managers to manage for the short-term, damaging the long-term prospects of the productive asset – the underlying corporation.</p>
<p>Mortgage-backed securities provide another example. The concept behind them is legitimate. Commercial banks are limited in the amounts they can lend based upon their capital reserves and the risk of the loans they already have made. When banks sell off some of their risk – as they do in the case of mortgage-backed securities – the amounts of money they are able to lend increases. So it is with other asset-backed instruments – car loans, consumer loans and the like. These assets, when kept within reason, are not speculative, because their return depends upon earnings from the underlying asset. And this behavior is good for the economy because it allows banks to lend more money in the productive economy.</p>
<p>When it becomes bad – when it becomes speculation – is when ever-increasing sums of money are invested in derivative products promising substantial returns that are not supported by the actual underlying earnings. At this point, money that could be invested in the productive economy is diverted to the purely derivative economy – the speculation economy – where it continues to recirculate until the inevitable crash.</p>
<p><a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1129340">Speculation</a> has been, and always will be, with us, whether in financial markets or otherwise, the Dodd-Frank Act notwithstanding. So we would do well to impose some restraints. </p>
<p>There are a number of ways we can control speculation, or at least keep it within bounds that might diminish its harm. Perhaps first among these is tax reform, as I’ve outlined in my previous <a href="http://www.amazon.com/gp/product/B0014TQJ7E?btkr=1">research</a> on the topic. Establishing a punitive capital gains tax regime for flipping an asset too quickly and something approaching tax relief for longer-term holdings, ideally on a sliding scale, would go a long way toward eliminating non-economic “investments.” </p>
<p>Changing accounting rules so that cash flow becomes more important than earnings per share is another strategy that would significantly reduce the opportunities for creative bookkeeping. It would also help to ensure that the underlying value of the asset can support the returns of the investment securities based on it. There are many more ways to help prevent good speculation from becoming parasitic, but these suggestions are, I hope, a good start.</p><img src="https://counter.theconversation.com/content/33613/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lawrence Mitchell has previously received funding from the Alfred P. Sloan Foundation and Ford Foundation to present conferences and other academic events.</span></em></p>The word “speculation” carries a connotation of negativity. And it’s probably fair to say that pretty much every financial crisis since the tulip mania of the 1630s can be attributed to some sort of mass…Lawrence Mitchell, Professor of Law, Case Western Reserve UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/135152013-04-16T04:14:28Z2013-04-16T04:14:28ZA bear in there: the fading fortunes of the gold market<figure><img src="https://images.theconversation.com/files/22494/original/gssnqbhy-1366078811.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">As the price of gold continues to plunge, many investors are wondering whether the shiny commodity has lost its lustre.</span> <span class="attribution"><span class="source">Flickr\Bullion Vault</span></span></figcaption></figure><p>It has been a turbulent time for the gold market. The past two days of trading have been particularly volatile, with gold prices recording the sharpest two-day drop <a href="http://www.reuters.com/article/2013/04/15/us-markets-global-idUSBRE88901C20130415">in 30 years</a> .</p>
<p>The severity of the fall has led market commentators to suggest the gold price is now entering a <a href="http://www.abc.net.au/news/2013-04-15/gold-prices-slump-as-investment-banks-recommend-sell-off/4629072">bear market phase</a>, with further falls expected in the future. A key explanation is that the outlook for the world economy is improving, and so investors are pulling out of safe haven investments and looking for investments that yield better returns. Furthermore, the possibility of Cyprus selling some of its gold reserves could have exacerbated this effect. </p>
<p>Perhaps the most important question is whether gold prices will continue to fall. There have been three recent falls in gold prices over the period from 2011 to the present. Reference to recent <a href="http://www.lbma.org.uk/pages/index.cfm?page_id=53&title=gold_fixings">London PM gold fixings</a> provides some insight into the volatility of gold prices over the past two to three years. While gold prices rose rapidly prior to 2011, there were four peaks in the reported London gold price fixing. The spot price reached US$1895 on the 5th and 6th of September in 2011; US$1795 on the 8th of November that year; US$1781 on February 28 2012 and US$1791.75 on October 4 2012. Spot prices have consistently fallen, up until the last couple of days when the prices plunged to US$1395 on April 15.</p>
<p>The fall in the gold price will also affect the unit price of exchange traded funds (ETFs), which hold gold and derivative contracts that are written on gold. Gold ETFs tend to hold gold bullion or take positions in derivative contracts written on gold, so if investors are no longer interested in holding gold as an investment, they will sell the units in gold ETFs as well as physical gold. These direct trades, along with arbitrage trading, will tend to drive down the unit price of gold EFTs and gold derivatives until they reflect the fall in the underlying gold price.</p>
<p>But it is difficult to predict whether the price of gold will continue to fall. To some extent, the price of gold moves with crude oil and other commodities. For example, the correlation coefficient between the monthly rate of change in gold price and crude oil price is around 0.20. This is not particularly large, but it does suggest that there is some common movement from month to month. There is also some evidence of longer term links between these two commodities. The crude oil price has been trading around US$95 per barrel over the past couple of years and gold has been trading around US$1650 or so, except for recent months. While we often see graphs of gold prices rising or falling over selected periods it is very difficult to predict where prices will go from day to day. This tendency for prices to wander almost aimlessly over time is often referred to as a random walk, though the gold price movements of the last couple of days look more like considerable stumbles. Regardless, it is very difficult to know which way commodity prices will move over the next few months.</p>
<p><a href="http://online.wsj.com/article/SB10001424127887323346304578423431110506270.html">Recent news from China</a> suggests that there could be a slowing in the demand for commodities in the coming year. Perhaps commodity prices generally will fall with the expectation that demand will not be so good in the near future. This would exert downward pressure on the gold price. </p>
<p>Yet, while global consumer sentiment is increasing of late, as measured by the <a href="http://research.stlouisfed.org/fred2/series/UMCSENT/">University of Michigan Consumer Sentiment Index</a> and by the Conference Board Consumer Confidence Index, consumer confidence is still well below the levels achieved prior to the global financial crisis. This lack of global confidence will tend to support gold prices because of the safe haven that gold provides for investors. </p>
<p>Is gold still a safe haven commodity? Gold can still be easily bought and sold. It is difficult to destroy and can be stored relatively safely and at quite low cost. These safe haven characteristics of gold have not changed, and there is still much to be concerned about with European debt and political instability across the world. The problem for safe haven assets such as gold is that they do not generate income. If prices are falling, then the gold investor is making losses; gold investments have been generating losses for some months now. </p>
<p>With recent slowing in the Chinese economy, the fall in demand for commodities generally will tend to further depress prices of commodities such as gold. This poses a problem for investors, who see growing equity markets around the world. They have invested in a metal that is safely stored in a bank vault, which is currently generating losses with each fall in the gold price. At some stage, they must decide to cut their losses on gold and invest in more profitable alternatives. Perhaps the current dramatic falls in the gold prices reflects a change in investor expectations. </p>
<p><em>Since publication, this story has been revised to reflect the following correction: gold prices recorded their sharpest two-day drop in 30 years. This error was made by the editor.</em></p><img src="https://counter.theconversation.com/content/13515/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Heaney receives funding from the ARC.</span></em></p>It has been a turbulent time for the gold market. The past two days of trading have been particularly volatile, with gold prices recording the sharpest two-day drop in 30 years . The severity of the fall…Richard Heaney, Winthrop Professor, The University of Western AustraliaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/120872013-02-11T04:49:13Z2013-02-11T04:49:13ZUK banking reform bill won’t curb reckless risk-taking<figure><img src="https://images.theconversation.com/files/20050/original/jdr86p6k-1360282652.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">More of the same: the UK government's banking reform bill is merely another capitulation to the banking lobby. </span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Some four and-a-half years after the banking crisis that has resulted in massive public debt and a deep austerity program, the UK government has finally unveiled its <a href="http://www.publications.parliament.uk/pa/bills/cbill/2012-2013/0130/2013130.pdf">Financial Services (Banking Reform) Bill</a> . The Bill is going through parliament and is expected to become law by the end of the year.</p>
<p>The legislation will require UK banks to insulate everyday banking activities associated with savings, deposits and loans from more volatile investment or speculative activities, by introducing a ringfence around the deposits of individuals and businesses. Thus two subsidiaries under the same parent company are envisaged. This separation is advocated because investment banking indulged in excessive risk-taking and accelerated the banking crisis. </p>
<p>Bear Stearns, Lehman Brothers and Northern Rock are often held out as exemplars of this reckless risk-taking. Prior to its <a href="http://news.bbc.co.uk/2/hi/business/7007076.stm">demise</a>, Northern Rock had a leverage ratio (the relationship between total assets and shareholder funds) of 50 while Bear Stearns and Lehman had leverage ratios of 33 and 30 respectively, thus making them highly vulnerable to small declines in the value of their assets. </p>
<p>For five years before its <a href="http://online.wsj.com/article/SB124182740622102431.html">collapse</a>, Bear Stearns generated almost all of its income from speculative activities. About 80% of Lehman’s income came from speculative activities. Other banks also indulged in an orgy of speculation and, by December 2007, the global face value of derivatives stood at <a href="http://www.bis.org/statistics/derstats.htm">$1148 trillion</a>, compared to a global GDP of only $65 trillion. No one can consistently pick winners and, when their financial fortunes turned, it set off a domino effect. </p>
<p>Many counter parties to complex financial instruments were in danger of defaulting on their obligations and thus threatened the collapse of whole system. The UK government bailed out the system with loans and guarantees of nearly £1 trillion.</p>
<p>Critics claim that ringfencing will increase administration costs and capital ratios, leading to reductions in the amount of credit in the economy and thus investment and jobs. The Bill is based on the premise that, in the next banking crisis, the government would rescue the retail side, but would probably let the investment side sink. This threat may discipline banks and spare taxpayers the expense of bailing out the entire system. The ultimate sanction is that if banks do not ringfence satisfactorily by 2019, then the regulator can formally split their operations.</p>
<p>The Bill sounds good, but is unlikely to be effective. It does not impose any personal costs for reckless risk-taking. Ringfencing is not the same thing as a legally enforced separation (two independent entities operating retail and investment banking). The Bill does not say what precisely is to be ringfenced as savings can be placed in many exotic securities. </p>
<p>Derivatives have been described by the US investment guru Warren Buffett as “financial weapons of mass destruction”, but the government has yielded to the banking lobby and will permit banks to locate “simple” derivative products — whatever “simple” means — within their retail banking operations. </p>
<p>What if funds flow from a ringfenced entity to non-ringfenced entity via a foreign subsidiary or affiliate in a place where there is no such separation? Would this be a breach of the ringfence? The Bill does not provide any examples of what a breach of ringfencing looks like, though the Treasury will have powers to prohibit unspecified types of transactions.</p>
<p>The lack of precision will fuel uncertainty and encourage banks to play creative games in deciding which side of the ringfence some assets and liabilities are to be shifted. The regulator is expected to negotiate the details with the banking industry.</p>
<p>Ringfencing will neither hermetically seal investment banking nor prevent its contagious effects from spreading. For its speculative activities, investment banks will continue to raise finance from retail banks, pension funds, insurance companies and others. They will still have the benefit of limited liability. </p>
<p>In the event of losses or a crash, investment banks will be able to dump their losses on to the providers of finance and thus infect the whole financial system, and will inevitably force governments to bail out the system again. The only remedy is to ensure that investment banking is accompanied by unlimited liability: investment banks are free to speculate as long as their owners can personally absorb the losses.</p>
<p>Investment banks may entice corporate executives to provide funds with promises of huge returns, which might boost their performance-related pay, but can land stakeholders with huge losses. Therefore, the Bill should have required that prior to transacting with investment banks, organisations should seek permission from their own stakeholders. </p>
<p>This would have prevented innocent bystanders from becoming the victims of speculators. Perhaps effective reforms will come after the next banking crash.</p><img src="https://counter.theconversation.com/content/12087/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>I receive financial services from banks but do not own shares in any. I do not act as a consultant to any bank and have neither sought nor received research grants from any bank.</span></em></p>Some four and-a-half years after the banking crisis that has resulted in massive public debt and a deep austerity program, the UK government has finally unveiled its Financial Services (Banking Reform…Prem Sikka, Professor of Accounting, Essex Business School, University of EssexLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/54952012-03-11T13:09:56Z2012-03-11T13:09:56ZWhy hedging a bet on Mother Nature is a hot commodity<figure><img src="https://images.theconversation.com/files/8088/original/mgw5kjgd-1330296403.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Derivatives can allow farmers to reduce their risk by guarding against changes in the weather.</span> <span class="attribution"><span class="source">Flickr</span></span></figcaption></figure><p>For some industries, the weather plays a significant role in determining revenue. Unexpected weather events can often cause significant financial losses. For instance, a drought can yield a severe impact on an agribusiness’ amount and quality of produce; unseasonably mild winters can similarly diminish the profit margins of utility companies. So, how can companies - particularly those at the mercy of Mother Nature - protect themselves against the elements and limit their exposure to financial risk? </p>
<p>Increasingly, companies have been managing weather risk by using derivatives, which provide the means for businesses to protect themselves against adverse financial affects that are due to variations in climate. According to industry body, the <a href="http://www.wrma.org/">Weather Risk Management Association</a>, trading volume of weather derivatives in 2010-2011 has <a href="http://www.wrma.org/pdf/WRMA2011IndustrySurveypressreleaseFINAL.pdf">increased by 20%</a> on the previous year.</p>
<p>Derivative contracts generally represent a contract to trade a specified quantity of an underlying asset, at an agreed price and time. The term “derivative” is used as they derive their value from movements in the price of an underlying asset. By making a payment to a separate company that will assume the financial weather risk for them, organisations are buying a type of insurance: the company assuming the risk will pay the purchaser a pre-set amount of money that will correspond to the loss or cost increase caused by the disruptive weather. As such, risk exposure can be managed in a wide range of settings.</p>
<p>Globally, derivative contracts trade on a wide range of underlying assets. These range from agricultural products (heat, wool, coffee, soy beans), energy (crude oil, natural gas), metals (eg gold, silver, copper) to financial assets (stock indices, interest rates). Such contracts allow both users and producers of agricultural goods, metals or energy, and investors in financial markets to manage their risk exposure to movements in the price of these underlying assets.</p>
<p>Weather derivatives on the other hand, derive their value from climatic conditions such as temperature, snowfall, hurricanes or rainfall. An important set of contracts traded on the <a href="http://www.cmegroup.com/trading/weather/">Chicago Mercantile Exchange</a> are temperature-based futures contracts. Contracts are offered for trade based on the temperature across a range of US, European and Australian cities such as Brisbane, Sydney and Melbourne.</p>
<p>The most common of these contracts come in the form of either Heating Degree Day (HDD) or Cooling Degree Day (CDD) contracts. The payoff of these contracts is based on the cumulated difference in daily temperatures relative to 18⁰C over a fixed period such as a month. The fixed level of 18⁰C is the temperature at which the energy sector believes little heating or cooling occurs in households. The buyer of a HDD or CDD contract benefits from a positive payoff if cumulative temperature is below or above a specified level. While this nomenclature may seem counter-intuitive, heating (or cooling) occurs when temperatures are lower (higher).</p>
<p>Major participants in this market include utilities and insurance companies, whose costs and or revenues are dependent upon weather conditions. In an Australian setting, an electricity supplier normally provides its customers with electricity at a fixed price irrespective of the wholesale price in the National Electricity Market. However, the wholesale price of electricity can fluctuate wildly with extreme weather conditions. CDD contracts can provide a hedging tool for such fluctuations in electricity prices in the wholesale market during periods of extremely high temperatures. Similar arguments apply in the northern hemisphere, where utilities face risk from increased demand during periods of low temperatures and hence HDD contracts are a natural hedging tool.</p>
<p>Futures on traditional assets such as stocks, bonds, agricultural and most energy products are priced under the cost of carry approach. The logic of this approach is that there are two alternatives for obtaining the asset in question at some point in the future. These are either, borrow to purchase it now and store the asset, or agree to purchase the asset at that later date via a futures contract. Under the absence of arbitrage, the cost of both approaches should be equivalent. Hence the current cost of a futures contract is related to the current price of the asset and the cost of borrowing and storing the asset. This arbitrage-free valuation approach is a simple yet common method for pricing many financial securities.</p>
<p>Weather derivatives have also gained research attention in academic circles as they represent unique pricing problem. The <a href="http://en.wikipedia.org/wiki/Cost_of_carry">cost of carry</a> method is based on the possibility of storing, or holding the underlying asset. (Financial securities such as stocks or bonds do not obviously require to be physically stored). However, in the case of weather contracts such as HDD or CDD, the underlying asset is not storable in any meaningful way.</p>
<p>As such, the cost of carry approach is not relevant and pricing is based on a discounted value of the payoff from the futures contract. A statistical model is required to generate the possible range of outcomes that the underlying weather index may take and subsequent payoffs ensuing from the derivatives contract. The discount rate will be market determined given the prices for contracts that the market will bear. </p>
<p>Weather derivatives are of great economic importance in that they allow participants to manage a very specific form of risk. While weather futures contracts currently make up a relatively small proportion of trading in derivatives markets, it is a sector that is experiencing rapid growth - particularly as more companies recognise the correlation between weather and profit.</p><img src="https://counter.theconversation.com/content/5495/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Adam Clements receives funding from the Australian Research Council.</span></em></p>For some industries, the weather plays a significant role in determining revenue. Unexpected weather events can often cause significant financial losses. For instance, a drought can yield a severe impact…Adam Clements, Professor of Finance, Queensland University of TechnologyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/55032012-02-23T19:32:48Z2012-02-23T19:32:48ZRisks or rewards? What the Volcker Rule means for Wall Street<figure><img src="https://images.theconversation.com/files/8018/original/q5g7mydd-1329969407.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The proposed Volcker Rule, which will ban proprietary trading by commercial banks, has raised the ire of Wall Street.</span> <span class="attribution"><span class="source">Bête à Bon-Dieu</span></span></figcaption></figure><p>The agenda of the <a href="http://www.asic.gov.au/asic/asic.nsf/byheadline/Summer+school?openDocument">Australian Securities and Investments Commission Annual Summer School</a> in Sydney was dominated by discussions on how to reduce systemic risk. </p>
<p>The noted increase in the regulatory perimeter does not necessarily equate to risk reduction. Dr Adrian Blundell-Wignall, senior representative of the Organisation for Economic Cooperation and Development, warned us that we are once again “off to the races”. </p>
<p>While undoubtedly an arresting metaphor, it also reflects ongoing concern that the banking industry has not internalised the social costs of the crisis. </p>
<p>Recent months have seen a marked resurgence in derivative trading. These derivative contracts far outweigh the actual underlying collateral. Mr Blundell-Wignall called on Australian, Asian and Canadian banks to prohibit proprietary trading or ring-fence retail from “casino banking” as a matter of urgency. </p>
<p>In a provocative speech, the OECD executive warned against complacency. He indicated that past self-imposed limitations on proprietary trading offered no guarantee of future trajectories with the region. Global restrictions were necessary to prevent the very regulatory arbitrage that banking executives in the United States argue will result as a consequence of attempts there to restructure the industry. </p>
<p>His comments come as US regulators work their way through voluminous submissions on the proposed <a href="http://en.wikipedia.org/wiki/Volcker_Rule">Volcker Rule</a>. The rule is named after the former chairman of the Federal Reserve, <a href="http://en.wikipedia.org/wiki/Paul_Volcker">Paul Volcker</a>. It was originally framed as a mechanism to restrict institutions protected by an implicit government guarantee from trading on their own account. </p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/NfiD3N267ok?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
</figure>
<p>The simplicity of the initial concept has transmogrified into a gargantuan formal proposed rule, informed by a maze of exceptions. The change prompted Dennis Kelleher (head of <a href="http://www.bettermarkets.com/">Better Markets</a>, a financial regulatory reform group) to declaim it as “<a href="http://dealbook.nytimes.com/2012/02/22/the-volcker-rule-made-bloated-and-weak/">the bastard child of the banking industry</a>”. </p>
<p>In a <a href="http://www.sec.gov/comments/s7-41-11/s74111-182.pdf">strongly worded letter</a> to regulatory authorities, Paul Volcker concurred, albeit using more diplomatic language. He argued that the rule could only work if the underlying purpose was reflected in banking culture. “My sense is that success is strongly dependent on achieving a full understanding by the most senior members of the bank’s management, certainly including the CEO, and the Board of Directors, of the philosophy and purpose of the regulation,” he wrote. </p>
<p>“Holding substantial securities in a trading book for an extended period obviously assumes the character of a proprietary position, particularly if not specifically hedged. Various arbitrage strategies, esoteric derivatives, and structured products will need particular attention, and to the extent that firms continue to engage in complex activities at the demand of customers, regulators may need complex tools to monitor them,” he continued. </p>
<p>The plaintive nature of the letter was touchingly naive. It prompted considerable ire rather than understanding from Wall Street. </p>
<p>“Paul Volcker, by his own admission, has said he doesn’t understand capital markets. Honestly, he has proven that to me,” the CEO of JPMorgan, Jamie Dimon fulminated. </p>
<p>He claimed that the reform risked disrupting legitimate market-making activity. Foreshadowing - but subverting - the argument made by Adrian Blundell-Wignall in Sydney, the JPMorgan executive argued that the proposed reform would not end the trading; it would merely send it overseas. </p>
<p>The debate is exceptionally revealing of the dynamics of financial regulation. </p>
<p>In total, over 14,479 submissions were submitted before the comment closing date. The vast majority took the form of individual variations of generic letters. These were coordinated by public advocacy groups, such as <a href="http://ourfinancialsecurity.org/">Americans for Financial Reform</a>. The scale of the campaign reflects ongoing public anger. In certain cases, it went beyond understandable - if inchoate - rage at the behaviour of the banks. </p>
<p>The <a href="http://www.occupythesec.org/">Occupy the SEC </a> movement offered a <a href="http://www.occupythesec.org/letter/OSEC%20-%20OCC-2011-14%20-%20Comment%20Letter.pdf">325-page critique</a>. It called for strengthening of the Volcker Rule, in particular a reverse of a planned exemption covering the sale of asset-backed securities. </p>
<p>“The Volcker Rule was woefully enfeebled by the addition of numerous loopholes and exceptions,” it argued. “We encourage the agencies to stand strong against the flood of deregulatory pressure that they have and will continue to face in connection with their implementation of the Volcker Rule.” </p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/8020/original/rb743pj6-1329971878.jpg?ixlib=rb-1.1.0&rect=318%2C7%2C481%2C627&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/8020/original/rb743pj6-1329971878.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=386&fit=crop&dpr=1 600w, https://images.theconversation.com/files/8020/original/rb743pj6-1329971878.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=386&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/8020/original/rb743pj6-1329971878.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=386&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/8020/original/rb743pj6-1329971878.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=485&fit=crop&dpr=1 754w, https://images.theconversation.com/files/8020/original/rb743pj6-1329971878.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=485&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/8020/original/rb743pj6-1329971878.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=485&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Economist Paul Volcker.</span>
<span class="attribution"><span class="source">AAP</span></span>
</figcaption>
</figure>
<p>The submission highlights the fact that battles over the trajectory of regulatory reform take place in the implementation stage. It also demonstrates that the nature of the engagement is itself circumscribed by the initial terms of reference, in this case the proposed exemptions. </p>
<p>Wall Street is not taking any chances. Over 240 submissions were lodged. Rather than relying on industry associations, individual corporations filed multiple comment letters. </p>
<p>The volume of submissions makes it highly unlikely that the Volcker Rule can be implemented on schedule in July this year without the SEC and other agencies risking a judicial challenge that they had failed to undertake sufficient cost-benefit analysis. </p>
<p>The delay is problematic for two reasons. </p>
<p>Internationally, postponement limits the impetus on other jurisdictions to pursue structural change in the industry. Domestically, the delay feeds into and facilitates an enormous increase in the cost of the upcoming presidential election. </p>
<p>The main Republican contender, Mitt Romney, has already pledged to revoke the Dodd-Frank Act, which provides the legislative basis for the Volcker Rule. </p>
<p>Mr Romney has received substantial support from <a href="http://restoreourfuture.com/">Restore Our Future</a>, a super <a href="http://en.wikipedia.org/wiki/Political_action_committee">political action committee (</a>PAC) dominated by securities and investments firms. </p>
<p>The super PAC has raised over $30 million already and invested $7.7 million in the Florida primary alone. The emergence of the super PAC (President Obama’s re-election committee also avails of one) derives from a Supreme Court ruling in 2010. It held that corporations had an unlimited right to exercise free speech. More broadly, Goldman Sachs and Citigroup, as well as private equity giant Blackstone, are among the biggest corporate donors to the Romney campaign. </p>
<p>Two self-evident truths emerge from the confluence on national and international agendas. </p>
<p>First, the presidential election will become much more expensive. Second, internal domestic imperatives in the United States makes the Volcker Rule at this stage more an exercise in rhetoric than reality. </p>
<p>The starter’s pistol has gone off. Not to fire a warning shot, but to signal a return to the races. </p><img src="https://counter.theconversation.com/content/5503/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Justin O'Brien receives funding from the Australian Research Council on two grants linked to global regulatory reform - 'The Future of Financial Regulation: Embedding Integrity Through Design' and 'The Limits of Disclosure: Private Rights, Public Duties and the Search for Accountable Governance' </span></em></p>The agenda of the Australian Securities and Investments Commission Annual Summer School in Sydney was dominated by discussions on how to reduce systemic risk. The noted increase in the regulatory perimeter…Justin O'Brien, Professor of Law, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.