TD Securities announced last week it is closing down some of its exotic derivatives businesses because of the escalating costs of compliance. Bob Dorrance, chairman and ceo of TD Securities, sent a memo to staff last week saying, "We do not believe we can attain the scale needed to carry the high infrastructure costs that are necessary due to the changing regulatory and accounting environment and the current scope of our business."
As first reported on DW's Web site, TD plans to cut its structured credit client business outside Canada and kill off its advanced equity products business. In addition, it will shelve its expansion plans for Asia.
John Hitchins, U.K. banking leader at PricewaterhouseCoopers in London, declined comment about TD Securities case in particular, but said any firm regulated by the Securities and Exchange Commission will find Sarbanes Oxley expensive to implement. It requires firms to test key controls annually and these controls have become more expensive for exotic derivatives as the instruments have gotten more complicated.
Hitchins noted, "The problem any small firm in derivatives has is they have to get more and more exotic just to stay in the game." He explained small firms get squeezed out of plain vanilla derivatives because as the instruments become more commodities the processing efficiencies of the big players starts to hurt. He said, "So small players have to maintain a big investment to stay ahead and that gets harder and harder."
Simon Gleeson, partner at Allen & Overy in London, said, "The cost of compliance has unquestionably gone up in the last five years." He thinks, however, that the costs are unlikely to be the only reason why any other firms would exit the derivatives market. One of the costs that has increased the most is IT, which has been driven by ever more sophisticated pricing, risk management and compliance. For example, derivatives houses are now incorporating tracking software into their trading desks and risk management to highlight trading activity before announcements in order to comply with the market abuse directive.
Gleeson thinks the general trend of regulation is in favor of the largest players because of economies of scale. He prophesied, "The rules of the club are occasionally in favor of the poor members, but the general trend is always in favor of the rich ones."
