Standardizing The Derivatives Industry

As regulators and others look to solve the problems that led to the current credit crisis, or at least look to find something to blame, derivatives are often an easy target. After all, most people don't understand them, let alone know what their benefits are. They simply know that derivatives are complex, risky, and make a fortunate few a lot of money.

A recent Reuters article highlights how regulators are looking to standardization of the over-the-counter derivative market as a potential solution to current problems. But will this help? While it may make future products easier to understand, it is also likely to prevent the type of innovation that is often needed to develop the products necessary for facilitating the transfer to risk to those who are best able to handle such risk. As such products are removed from the system, it is likely that the Government will increasingly be forced to come to the rescue, nationalizing more risk at the taxpayer's expense. As an example, there is no doubt that the credit default swap market needs to be more transparent, but can this be done without standardization, or simply putting everything through the same cookie-cutter framework? While such a system could help eliminate large losses, it may be at the expense of slower growth and innovation. Hopefully regulators will continue to take this into consideration.