JPMorgan's North American equity research analysts have published a new report on the impacts of proposed US OTC derivatives legislation. The report suggests that such legislation presents a new revenue opportunity for both exchanges and dealers, particularly around clearing and notably for CDS instruments.

The report explains: "Our analysis indicates that the various pieces of OTC derivative legislation will have a material impact on the way derivatives are traded. We believe greater capital requirements for financial services companies will drive more OTC derivatives to be cleared. As a result, more OTC trades will be standardised and will be better positioned to trade electronically on alternative swap execution platforms."

It continues: "This will likely drive OTC volumes materially higher and with them listed derivate volumes. Furthermore, we expect clearing fees and other income could rise to an US$8bn opportunity for the clearinghouses and dealer FCMs."

The JPMorgan analysts estimate that the independent and exchange-owned clearinghouses could generate US$3.7bn of revenue from the clearing of OTC derivative trades. They indicate that the biggest revenue generator is likely to be interest rate products, but argue that CDS is the most exciting sector, given the complexity of the product and the ability to generate higher fees per US$1m traded.

Consequently, the analysts forecast clearinghouse revenue of US$1.1bn, but stress that their figures do not include revenue sharing with the dealers. As a result a 50% haircut is likely appropriate.

The report adds that regulatory pressure has encouraged dealers to implement new standardised contracts, which the analysts expect will lead to a significant increase in the size of the clearable market as pre-existing contracts mature and as newer contract types permeate the OTC derivative trading world. Because of the significantly higher capital and margin charges for non-standardised transactions, the report suggests that trading behaviour will change and to migrate to standardised products that are clearable.

As a result, the analysts believe that most CDS products will be clearable within two years. "We expect the vast majority of the CDS market will be clearable, both for indexes and for single securities. Our assumption is based on the high percent of new trades that are clearable in the dealer-to-dealer business, which we think is applicable to the dealer to financial customer segment. We acknowledge that the majority of dealer to non-financial institution business is customised, but that higher capital charges for dealers and banks will lead that business to migrate to more standardised and therefore more clearable securities over time," they explain.

At the same time, the report envisages the likelihood of clearing consolidation. It notes: "There are four CCPs that will or have offered clearing services for CDS - we think that should consolidate to fewer... The rationale for consolidation of clearinghouses is that cross-margining benefits by pooling open interest within the same asset class will drive clearing customers to focus their business with one clearing entity."