Beneficiares of the market meltdown

So we have a once in a lifetime meltdown caused by a bunch of Wall street banks thought to be infallible, going down bankruptcy lane or going to the government with a begging bowl to save their skin. Made me think, is there anyone out there who benefits from the change in environment.

Well, we finally have a strong push for changes in the regulatory environment that makes Wall Street banks, especially ones that are pure play investment banks, come under the ambit of regulations set by the federal reserve. One of the changes proposed could substantially change the face of the OTC (over the counter) market. Currently, the entire forwards market trades over the counter. It is estimated the interest rate swaps that use LIBOR as a benchmark is close to $345 trillion. Yes, that’s trillion. In addition, the credit default swap market, another OTC market was at its peak, a $61 trillion market. These markets were essentially operated by large wall street banks which were considered to be infallible and therefore counterparty risk was never an issue.

The fall of Lehman however changed the dynamics forever. The repurcussions of the fall of the relatively small Wall Street bank were felt worldwide resulting a terrible October month that was felt even by the common man on the street. A large part of this pain was felt due to counterparty risk.

Exchanges are meant precisely to take care of counterparty risk. New regulations to standardize trading over exchanges mean a bonanza for these firms. Imagine what can happen if an additional $400 trillion worth of trading happens over exchanges instead of the OTC market. The fees that they could generate over trading could be staggering. This represents a huge growth are for these firms. We therefore have firms like the Chicago Mercantile Exchange, InterContinental Exchange and NYSE Euronext racing to create trading platforms for these forwards and credit default swaps.

So how about these as investment opportunities? These firms trade in U.S markets under the tickers, CME, ICE and NYX and are trading at extremely low historical valuations. This is so not just because the market meltdown but also due to lower trading volumes that lead to lower fees and therefore, lower revenues.

The future for these exchanges is bright though. Growth opportunities are significant and valuations, extremely compelling. Smells like a good opportunity, doesn’t it?